** **

**SECURITIES AND EXCHANGE COMMISSION**

**WASHINGTON,D. C. 20549**

 

**FORM 10-K**

** **

**ý** AnnualReport Pursuant to Section 13 or 15(d)of the Securities Exchange Act of 1934

** **

**o** TransitionReport Pursuant to Section 13 or 15(d)of the Securities Exchange Act of 1934

** **

**FOR THE  FISCAL YEAR ENDED DECEMBER 31, 2004**

 

**COMMISSIONFILE NUMBER**

**0-32667**

** **

**CAP ROCK ENERGY CORPORATION**

** **
| **Texas**                                                                                              | ** ** | **75-2794300**                            |
|--------------------------------------------------------------------------------------------------------|------------|-------------------------------------------|
| **(State of  Incorporation)**                                                                          | ** ** | **(I.R.S. Employer  Identification No.)** |
| ** **                                                                                             | ** ** | ** **                                |
| **500 West  Wall Street, Suite 400  Midland, Texas**                                                   | ** ** | **79701**                                 |
| **(Address of principal  executive office)**                                                           | ** ** | **(Zip Code)**                            |
| ** **                                                                                             | ** ** | ** **                                |
| **Registrant’s telephone number, including area  code     **432-683-5422 |

 

Securities registered pursuant to Section12(b) of the Act:

** **
| **Title of Each Class**                     | ** ** | **Name of each exchange on which registered** |
|---------------------------------------------|------------|-----------------------------------------------|
| ** **                                  | ** ** | ** **                                    |
| **COMMON  STOCK, PAR VALUE $.01 PER SHARE** | ** ** | **AMERICAN  STOCK EXCHANGE**                  |

 
| **Securities registered pursuant to Section  12(g) of the Act:     **NONE |
|----------------------------------------------------------------------------------------------------|

** **

**Indicate by check markwhether the registrant (1) has filed all reports required to be filed bySection 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding12 months (or for such shorter period that the registrant was required to filesuch reports), and (2) has been subject to such filing requirements for thepast 90 days.**

 

Yes     ý          No     o

 

Indicate bycheck mark if disclosure of delinquent filers pursuant to Item 405 ofRegulation S-K is not contained herein, and will not be contained, to the bestof registrant’s knowledge, in definitive proxy or information statementsincorporated by reference in Part III of this Form 10-K or any amendment tothis Form 10-K.  ý

 

**Indicate by check mark whether the registrant is anaccelerated filer (as defined in Rule 12b-2 of the Act).**

** **

Yes     o       No    ý    

** **

**THEAGGREGATE MARKET VALUE OF THE COMMON STOCK HELD BY NON-AFFILIATES OF THEREGISTRANT AS OF JUNE 30, 2004, WAS APPROXIMATELY $33,882,696 BASED ON THECLOSING PRICE OF $27.10 FOR THE COMMON STOCK ON THE AMERICAN STOCK EXCHANGE ASREPORTED BY THE WALL STREET JOURNAL.**

** **

**THE NUMBER OF SHARES OF COMMON STOCK OUTSTANDINGON MARCH 21, 2005, WAS 1,625,798.**

** **

**DOCUMENTS INCORPORATED BY REFERENCE**

** **

**Portionsof the Registrant’s definitive Proxy Statement for the 2005 annual meeting ofits shareholders, which will be filed with the Commission not later than April29, 2005,  are incorporated by referenceinto Part III of this report.**

** **

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** **

**PART I**

** **

**ITEM 1.BUSINESS**

** **

**The Company**

** **

**Cap Rock Energy Corporation, its subsidiariesand affiliates (the “Company”) are engaged in the distribution and transmissionof electricity in various noncontiguous areas in the State of Texas. TheCompany serves approximately 33,500 meters in 28 counties in Texas.  The Company had approximately $200 million ofassets at December 31, 2004, and generated revenues of approximately $83million in 2004.  The Company isregulated primarily by the Public Utility Commission of Texas and the FederalEnergy Regulatory Commission.  TheCompany is an exempt holding company under the provisions of the Public UtilityHolding Company Act of 1935, and is exempt from all provisions of that act,except the section relating to the acquisition of the securities of otherutilities.**

** **

**The Company’s predecessor, Cap Rock ElectricCooperative, Inc. (the “Cooperative” or the “Predecessor”), was incorporated asan electric cooperative in the State of Texas in 1939.  In 1998, members of the Cooperative adopted aplan for changing the corporate structure from a member owned cooperative to ashareholder owned corporation, and the Company was formed.  The transfer of the assets, liabilities andissuance of stock was completed by early 2002.  Transfer of the Cooperative’s Certificate of Convenience and Necessity (“CCN”),which allows a company to provide electric utility services within a certifiedterritory in Texas, to the Company was approved by the Public UtilityCommission of Texas (“PUCT”) effective September 1, 2003.**

** **

**During the 2003 Texas legislative session,Senate Bill 1280 (“SB 1280”) was adopted which effectively brought the Companyunder the jurisdiction of the PUCT.  See “Stateand Federal Regulation – State Regulation.”**

** **

**ElectricMarket**

** **

**The electric industry is currently undergoingmany changes, both in Texas and nationwide. Total revenues from sales of electricity to ultimate consumers in theUnited States total over $250 billion per year. While the Company is not currently subject to competition, it hasoperated in dually certified areas since its existence.  Since the Company is regulated by the PublicUtility Commission of Texas, it will be subject to competition in thefuture.   See State and FederalRegulations – State Regulation.**

** **

**The Company has experience serving customers inmore sparsely populated areas, a majority of which are dually certified withanother utility.  This experience in acompetitive market place gives the Company an advantage over other similarsized utilities.  The Company expectsthat as competition becomes more intense and operations become morecomplicated, more utilities will want to divest themselves of customers inthese sparsely populated areas.  See alsoBusiness Strategy.**

** **

**BusinessStrategy**

** **

**The Company’s objective is to become a nationalelectric distribution company, with community focused local operatingdivisions.  The strategy is to grow byacquiring small to medium sized electric distribution businesses in rural areasthat have significant potential for growth. This may include acquiring smaller utilities or pieces of largerutilities in these types of rural areas.**

 

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**DistributionOperating Statistics**

** **
| ** **            | ** ** | **2004**                   | ** ** | **2003** | ** ** | **2002** | ** ** |
|-----------------------|------------|----------------------------|------------|----------|------------|----------|------------|
| ** **            | ** ** | **(Thousands of dollars)** | ** ** |
| **Revenue:**          |       |                       |       |     |       |     |       |
| Residential           |       | $                          | 29,636     |     | $          | 30,754   |       | $ | 27,509 |   |
| Large commercial      |       | 20,242                     |       | 19,345   |       | 16,161   |       |
| Small commercial      |       | 22,247                     |       | 20,979   |       | 18,848   |       |
| Irrigation            |       | 6,078                      |       | 5,683    |       | 6,123    |       |
| Other                 |       | 546                        |       | 2,317    |       | 2,263    |       |
| Farmersville contract |       | 2,400                      |       | 2,324    |       | 2,431    |       |
| Total  Electric Sales |       | $                          | 81,149     |     | $          | 81,402   |       | $ | 73,335 |   |

 
| ** **                        | ** ** | **2004** | ** ** | **2003** | ** ** | **2002** | ** ** |
|-----------------------------------|------------|----------|------------|----------|------------|----------|------------|
|                              |       |     |       |     |       |     |       |
| **Meters (active and inactive):** |       |     |       |     |       |     |       |
| Residential                       |       | 27,900   |       | 28,753   |       | 27,072   |       |
| Large commercial                  |       | 1,560    |       | 1,553    |       | 1,500    |       |
| Small commercial                  |       | 11,356   |       | 11,398   |       | 10,939   |       |
| Irrigation                        |       | 3,138    |       | 3,131    |       | 3,122    |       |
| Farmersville contract             |       | 1,556    |       | 1,535    |       | 1,734    |       |
| Total Meters                      |       | 45,510   |       | 46,370   |       | 44,367   |       |

 
| ** **            | ** ** | **2004** | ** ** | **2003** | ** ** | **2002** | ** ** |
|-----------------------|------------|----------|------------|----------|------------|----------|------------|
|                  |       |     |       |     |       |     |       |
| **Deliveries (mWh):** |       |     |       |     |       |     |       |
| Residential           |       | 252,935  |       | 276,133  |       | 261,664  |       |
| Large commercial      |       | 219,629  |       | 216,675  |       | 203,030  |       |
| Small commercial      |       | 195,889  |       | 192,499  |       | 182,497  |       |
| Irrigation            |       | 44,741   |       | 44,612   |       | 54,483   |       |
| Other                 |       | 54       |       | 63       |       | 52       |       |
| Farmersville contract |       | 27,674   |       | 28,560   |       | 27,287   |       |
| Total  Deliveries     |       | 740,922  |       | 758,542  |       | 729,013  |       |

** **

**Revenues andCustomers**

** **

**The Company’s operating revenues come fromelectric or electric related sales. Annual sales for 2004 to the Company’scommercial/industrial, residential and irrigation customers accounted forapproximately 54%, 38%, and 8%, respectively, of total electric sales.  This trend has remained fairly constant.**

** **

**Commercial and industrial revenues, derivedprimarily from electric powered oilfield equipment, are generally not subjectto seasonal fluctuation, or normal oil price fluctuations. This is because manyproducers have pre-committed their output. Electric power requirements can, however, be affected by a dramatic changein the price of oil, which affects the overall market for oil.  Oil and gas prices have risen over the pastfew years.  Oilfield activity, and thuselectric demand and consumption, may increase because of new drilling programsand the resulting new production.**

** **

**Residential sales vary with temperaturefluctuations, primarily during the summer months, as the Company’s residentialcustomers use more electric power for cooling during the hot summer months.Historically, approximately 30% of the Company’s annual residential sales occurduring the period July 1 to September 30.**

 

3

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**Irrigation revenues, derived primarily fromcotton farmers with electric powered irrigation equipment, are subject totemperature and rainfall fluctuations during the cotton planting and growingseasons. Although irrigation sales are only 8% of all electric sales for 2004,approximately 80% of those irrigation sales occurred during the period April 1to  September 30.**

** **

**NonutilityInvestments and Property**

** **

**As of December 31, 2004, the Company’s onlynonelectric business investment is an office building and the related land thatserves as its general corporate headquarters in Midland, Texas.**

** **

**The Company previously had a 42% interest inMAP Resources, Inc. (“MAP”) which it accounted for under the equity method ofaccounting.  Effective October 8, 2003,the Company reached an agreement with MAP to sell its entire interest inexchange for a note receivable of $1,250,000, which was repaid in July 2004.**

** **

**The Company had a 15% interest in United Fueland Energy Company (“United Fuel”), which is engaged in the petroleumdistribution business.   The Company alsohad a note receivable from United Fuel which was extinguished by United Fueltaking the Company’s position as borrower on a cross-collateralized notepayable.  The Company was a secondaryguarantor on United Fuel’s note of $3,500,000, which United Fuel repaid inNovember  2004, and the Company wasreleased from the guaranty.**

** **

**In March 2004, the Company signed an agreementwith a shareholder of United Fuel to sell the Company’s shares of stock inUnited Fuel for $1,300,000 in exchange for a note receivable from thatshareholder.  See Notes 7 and 16 to theconsolidated financial statements.**

** **

**The Company had limited partner interests inreal estate partnerships that it sold in February 2004, to an unrelated thirdparty in exchange for a note receivable. See Notes 7 and 9 to the consolidated financial statements.**

** **

**Employees**

** **

**As of December 31, 2004, the Company had 111full-time and six part-time employees, none of which were members of any laborunions.**

** **

**State andFederal Regulation**

** **

***StateRegulation***

** **

Asa Texas electric utility, the Company is subject to the jurisdiction of thePublic Utility Commission of Texas, which has general regulatory authority over rates, certificatedterritory, and the sale of certain facilities. At the time of the Company’s conversion from anelectric cooperative to an investor owned electric utility, the Texas PublicUtility Regulatory Act (“PURA”) provided that a successor to an electriccooperative, such as the Company, would be treated as a cooperative forregulatory purposes. This would have allowed the Board of Directors of theCompany to continue to set the rates that it charges its customers and to decidewhen and if to enter into competition. However, during the 2003 Texaslegislative session, SB 1280 was adopted which amended the PURA so that theCompany would be treated as an investor owned utility subject to regulation bythe PUCT.  The Company’s rates are now subject toregulation and approval by the PUCT, rather than the Company’s Board ofDirectors, and the PUCT will determine how and when the Company will enter intocompetition.

 

**Inaccordance with this change in the PURA, the Company filed its electric servicetariffs with the PUCT in September 2003. A hearing will be held in April, 2005 to determine if the tariffs filedby the Company are the tariffs that were approved by the Company’s Board ofDirectors, which was the Company’s previous regulatory authority.  The Company believes the issue is mootbecause any current tariff will be superseded by the tariff that is ultimatelyapproved by the PUCT in the current rate case. In addition, the PUCT initiated an inquiry to determine the reasonablenessof the Company’s electric rates and required the Company to submit a ratefiling package.**

 

4

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**TheCompany submitted that rate filing package in late February 2004.  A hearing on the Company’s filing, whichincluded a request for a rate increase, was held in October 2004.  On March 17, 2005, the Administrative LawJudges (“ALJ’s”) issued a Proposal for Decision (“PFD”).  The PFD recommended a 7.49% rate decrease forCap Rock.  This amounts to an annual revenuedecrease of approximately five million dollars. Several intervenors had sought rate decreases which were much largerthan the recommendation of the ALJ’s.  Afinal ruling, which can be appealed by Cap Rock or any of the intervenors, isexpected by June 2005.**

** **

**TheCompany feels that its rates and its requested rate increase are justified andthat the evidence supports that.  TheCompany will request that the PUCT reject the recommendation of the ALJ’s andgrant its requested rate increase.  TheCompany has received recommendations from Administrative Law Judges in the pastwhich were not in its favor, only to prevail when the issues were considered bythe PUCT.  The Company believes its ratesare reasonable and that the requested rate increase is appropriate based uponits cost of service and reasonable return on its rate base.  However, the Company cannot determine whataction the PUCT will take with respect to the PFD.   Notes 19 and 22 to the consolidatedfinancial statements.**

** **

***FederalRegulation***

** **

Asubsidiary of the Company, NewCorp Resources Electric Cooperative, Inc. (“NewCorp”)owns the transmission system that serves the west Texas divisions and issubject to the jurisdiction of the Federal Energy Regulatory Commission (“FERC”).  FERC has authority over wholesale sales ofelectricity, the interstate transmission of electric power, maintenance ofaccounting records in accordance with the uniform system of accounts and theissuance of certain securities.  See alsoNote 22, “Commitments and Contingencies,” to the consolidated financialstatements.

 

**The 1992 Energy Policy Act began deregulatingthe electricity market for generation. The Energy Policy Act permitted FERC to order electric utilities toallow third parties to use their transmission systems to sell electric powerto  wholesale customers.  In 2003, NewCorp applied for and receivedpermission from FERC to charge open access transmission system rates forwholesale transactions.  FERC alsorequires the Company to provide transmission services to others under terms comparable  to those we provide ourselves.  In December 1999, FERC issued an order (FERCOrder No. 2000) encouraging formation of regional transmission organizations(RTOs).  RTOs are designed to control thewholesale transmission services of the utilities in their regions, therebyfacilitating open, and more competitive, markets in bulk power.  In February of 2004, FERC issued an ordergranting RTO status to the Southwest Power Pool (“SPP”).**

** **

**The Company and all other electric utilitieswith interstate transmission facilities operate under FERC regulated openaccess tariffs that offer all wholesale buyers and sellers of electricity thesame transmission services, at the same rates, that the utilities providethemselves.   During 2002, the Companyapplied for, and FERC approved, the unbundling of transmission rates relatingto its west Texas transmission system. Our 305 mile transmission system that serves the west Texas division iscurrently in the SPP.   The Company istherefore under the jurisdiction of the SPP through Southwestern Public ServiceCompany, its wholesale power provider for west Texas.  Management believes that FERC Order No. 2000and continued participation in the SPP will not have a material effect on itsoperations.**

** **

**Competitionand Restructuring in the Utility Industry**

** **

**For many years the Company and its predecessorhave faced competition in providing electric distribution services.  A large percentage of its service territoryis dually certified with other utilities, therefore even though the Company isnot currently subject to competition pursuant to the legislation that waspassed in Texas in 1999, it competes with other utilities in much of itsservice territory.  Many of the Company’scompetitors, like TXU Energy and its affiliate, TXU-Electric Delivery, are muchlarger than the Company and have financial resources that are  much greater than the Company’s.  TXU-Electric Delivery, which is the largestelectric utility in the State of Texas in terms of revenues and size ofoperating areas, is certified to operate in many of the areas in west Texaswhere the Company currently operates, and the Company competes with it on thebasis of price and service.  The Company’sretail rates are comparable to those of TXU-Electric Delivery and other retailelectric providers.**

 

5

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**Legislation passed in Texas in 1999, whichbecame effective January 2002, will significantly modify the industry andpotentially introduce more competition into the Texas retail market.  In the future, the Company’s customers may beable to purchase electricity from other providers, not just those certified toserve in the service territory.  However,the Company will continue to provide distribution services and receive a wirescharge.**

** **

**The National Energy Policy Act empowers theFederal Energy Regulatory Commission to require utilities to providetransmission facilities for the delivery of wholesale power from other powerproducers to qualified resellers, such as municipalities, cooperatives andother utilities.  The Company’stransmission facilities in its west Texas divisions, which are in the SouthwestPower Pool, are subject to regulation by the Federal Energy RegulatoryCommission, and the Company’s transmission facilities in its central Texasdivision, which are part of the Electric Reliability Council of Texas, Inc.,are subject to regulation by the PUCT. See Note 19 to the consolidated financial statements.**

** **

**PowerRequirements**

** **

**The Company purchases power for resale to itsretail customers from wholesale suppliers and distributes that power to itscustomers through approximately 305 miles of transmission lines andapproximately 11,000 miles of distribution lines.  The Company’s transmission systems interconnectwith the systems of power suppliers and other utilities, to permit bulk powertransactions with other electricity suppliers. The Company, owns and operatesthe transmission system that supplies wholesale power to the Company’s westTexas divisions,   which is a part of theSouthwest Power Pool.  SPP coordinatestransmission services among its members. In 2004, the Company purchased all electric power pursuant to wholesaleelectric power contracts with Southwestern Public Service Company (“SPS”), LowerColorado River Authority  (“LCRA”) andGarland Power and Light (“Garland”), which accounted for approximately 74%, 13%and 13%, respectively, of the electric power purchases of the Company.Generally, the wholesale electric power supply contracts are based on fixedcharges for kWh usage, transportation and auxiliary services and a variablecharge for fuel based on kWh usage. The Company’s purchased power costsfluctuate primarily with the price of natural gas. The contracts with SPS andLCRA expire in 2013 and 2016, respectively. The contract with Garland had an expiration date of 2004, and wasextended until 2005; the Company has completed the process of requestingproposals for power providers and expects to have a contract signed within thenext few months.  Because the marketprice of gas has increased, Management expects the price to be higher.  We cannot predict what effect, if any,renegotiation of future expiring contracts may have on the Company’s financialcondition and results of operations. However, there is adequate supply of powerand generation within the region should the Company need alternative powersupplies.  All costs associated withpurchased power are passed through to the retail customer.**

** **

**EnvironmentalMatters**

** **

**The Company is subject to federal and stateregulations with respect to certain environmental matters.  The Company is unaware of any present orpotential environmental problems and believes it is in compliance with allenvironmental regulations.  The lawsapplicable to environmental concerns can change rapidly and are difficult topredict. Substantial expenditures may be required to comply with these everchanging regulations. The Company analyzes the potential costs arising fromenvironmental matters on an ongoing basis.**

** **

**Constructionand Capital Requirements**

** **

**The Company has no major construction projectsplanned at the present time. Utility construction expenditures for 2005 willconsist primarily of costs to maintain the Company’s distribution andtransmission systems. Total gross property additions, including constructionwork in progress, for the years ended December 31, 2004, 2003 and 2002, were$3,228,000, $5,209,000 and $1,517,000, respectively.  Management’s planned capital expenditures forthe next 12 months are $7,916,000.**

 

6

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**Company Website**

** **

**The Company’s website address iswww.caprockenergy.com.  The Company’sreports on Form 10-K and quarterly reports on Form 10-Q are available free ofcharge at this website.  These reportsare made available on the website as soon as practicable after electronicallyfiling with, or furnishing to, the Securities and Exchange Commission.  The information contained on the website isnot part of this document.**

** **

**ITEM 2.PROPERTIES**

** **

**Utility Plant**

** **

**The Company owns and operates a transmissionsystem and distribution systems.  Thetransmission system carries high voltage electricity over longerdistances.   Substations step the voltagedown and distribution lines carry that power to the ultimate customers.  The Company’s transmission system that servesthe west Texas divisions consists of 16 substations and 305 miles of singlepole transmission line that was constructed over a period of several yearsbetween 1975 and 1995.  The system providesa looped transmission line at 138 kV that provides for two electric supplydelivery points for power providers to tie into and deliver power.  The 16 substations supply sixty-sixdistribution line circuits, which serve over 9,800 miles of primary and secondarydistribution line in 17 countywide areas and supplies approximately 120 MW ofpeak electrical power.  When thetransmission system was being constructed, a large portion of the distributionsystem was rebuilt to accommodate the new substations, as well as new feedercircuits being constructed with larger conductors and a higher distributionvoltage.  Many of the distributioncircuits can also be fed from alternative substations in order to minimizeoutage time.  The Company has two othernoncontiguous distribution systems with nine. The Company also owns real estate related to its electric distributionand transmission business, including easements, right-of-ways, and land wheresubstations, as well as distribution and transmission poles and lines, arelocated.  Real estate and division officelocations in Stanton, Colorado City, Brady and Celeste, Texas, are alsoowned.  The distribution system ispledged as security under the Company’s mortgage notes.**

** **

**Nonutility Property**

** **

**The Company owns a 45,000 square foot officebuilding and the related land that is used as its general corporateheadquarters in Midland, Texas. The Company occupies approximately 35% of thebuilding and the remainder is leased to commercial tenants.**

** **

**In February 2004, the Company sold its limitedpartner interests in real estate partnerships for $286,000 in exchange for anote receivable, which resulted in no gain or loss.  In prior years, the Company had guaranteeddebt of some of the partnerships with the maximum exposure of such guaranteesaggregating $5,178,000 at December 31, 2003. The sale of the interests also involved the transfer of those guaranteesto the buyer.  See Notes 7 and 9 to theconsolidated financial statements.**

** **

**ITEM 3.LEGAL PROCEEDINGS**

** **

**The Company is involved in legal andadministrative proceedings and claims of various types, which arise in theordinary course of business.  In theopinion of Management, based upon information furnished by counsel and others,the ultimate resolution of these claims, except for the proceedings describedin Note 22 to the consolidated financial statements, will not have a materialimpact on the Company’s financial position, operating results or liquidity.**

** **

**See Note 22, “Commitments and Contingencies,”to the consolidated financial statements for a discussion of legal proceedingswhich may be material to the Company’s operations and financial condition.**

** **

**ITEM 4.  SUBMISSION OF MATTERS TO A VOTE OF SECURITYHOLDERS**

** **

**There were no matters submitted to a vote ofsecurity holders during the fourth quarter of 2004.**

 

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**ExecutiveOfficers of the Registrant**

** **

**The executive officers of the Company are asfollows:**

** **
| **NAME**               | ** ** | **AGE**    | ** ** | **POSITION**                                                      |
|------------------------|------------|------------|------------|-------------------------------------------------------------------|
| **David W. Pruitt**    | ** ** | **58**     | ** ** | **Co-Chairman of the Board and Chief Executive  Officer**         |
| ** **             | ** ** | ** ** | ** ** | ** **                                                        |
| **William L. West**    | ** ** | **48**     | ** ** | **President**                                                     |
| ** **             | ** ** | ** ** | ** ** | ** **                                                        |
| **Ulen A. North. Jr.** | ** ** | **59**     | ** ** | **Executive Vice President**                                      |
| ** **             | ** ** | ** ** | ** ** | ** **                                                        |
| **Lee D. Atkins**      | ** ** | **61**     | ** ** | **Senior Vice President, Chief Financial  Officer and Treasurer** |
| ** **             | ** ** | ** ** | ** ** | ** **                                                        |
| **Sammy C. Prough**    | ** ** | **54**     | ** ** | **Vice President and Chief Operating Officer**                    |
| ** **             | ** ** | ** ** | ** ** | ** **                                                        |
| **Ronald W. Lyon**     | ** ** | **49**     | ** ** | **Vice President, General Counsel and Secretary**                 |
| ** **             | ** ** | ** ** | ** ** | ** **                                                        |
| **Celia B. Page**      | ** ** | **56**     | ** ** | **Vice President, Controller and Assistant  Secretary/Treasurer** |

** **

***DavidW. Pruitt*** has served as President and Chief Executive Officer of theCompany since its inception and as Co-Chairman of the Board since February2001.  He served in those same positionsfor the Cooperative from 1987 until its dissolution in 2004.

** **

***WilliamL. West*** became President of the Company in December 2004 and wasappointed to serve on the Board of Directors at the same time.  He served as a consultant to the Company fromJuly through December 2003 and joined the Company full time in January 2004 asChief Strategic Officer, and was appointed Vice-President in July 2004.   Prior to this he was a Senior Manager withKPMG, LLC serving in client service and strategic corporate tax consultingcapacities from 1997 through July 2003. Mr. West is a certified public accountant.

** **

***UlenA. North, Jr***. has served as Executive Vice President of the Companysince its inception.  He served in thatsame position for the Cooperative from December 1996 until its dissolution in2004.

** **

***LeeD. Atkins*** has served as Senior Vice President and Chief FinancialOfficer of the Company since September 2001, and Treasurer since August 2002.He served as Executive Vice President/Chief Financial Officer of RedMeteor.com,Inc. from August 2000 until September 2001, and as Vice President/CFO of CSWEnergy from February 1992 until August 2000.

** **

***SammyC. Prough*** has served as Vice President and Chief Operating Officerof the Company since its inception.  Heserved in the same position for the Cooperative from June 1999 until itsdissolution in 2004.

** **

***RonaldW***. *Lyon* has served as Vice President andGeneral Counsel of the Company since October 2001, and Secretary since August2002. Prior to that, he was engaged in the private practice of law and servedas full-time general counsel to the Cooperative from 1993 until its dissolutionin 2004.

** **

***CeliaB. Page*** joined the Company as Controller in July 2001, and waselected to serve as Assistant Secretary/Treasurer in August 2002, and VicePresident in December 2002.  Shepreviously served as Senior Vice President and Controller of Costilla Energy,Inc. from April 1996 until July 2001. Ms. Page is a certified public accountant.

 

8

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**PART II**

** **

**ITEM 5.   MARKET FOR REGISTRANT’S COMMON EQUITY ANDRELATED STOCKHOLDER MATTERS**

** **

**MarketInformation and Holders of Common Stock**

** **

**The following table sets forth the range ofhigh and low sales prices per share of common stock for the periods shown, asreported in the consolidated reporting system of the American Stock Exchange.**

** **
| ** **     | ** ** | **Sales Price** | ** ** |
|----------------|------------|-----------------|------------|
| ** **     | ** ** | **High**        | ** ** | **Low** | ** ** |
| **2004**       | ** ** | ** **      | ** ** | ** ** | ** ** |
| First Quarter  |       | $               | 34.50      |   | $ | 30.52 |   |
| Second Quarter |       | 32.30           |       | 27.10 |   |
| Third Quarter  |       | 30.70           |       | 23.40 |   |
| Fourth Quarter |       | 30.40           |       | 24.60 |   |
|           |       |            |       |   |   |
| **2003**       | ** ** | ** **      | ** ** | ** ** | ** ** |
| First Quarter  |       | 32.99           |       | 27.85 |   |
| Second Quarter |       | 35.50           |       | 17.51 |   |
| Third Quarter  |       | 21.50           |       | 10.35 |   |
| Fourth Quarter |       | 11.85           |       | 10.25 |   |
|                |            |                 |            |  |  |  |  |

 

**As of March 21, 2005, there were approximately12,148 holders of record of the Company’s common stock.**

** **

**DividendPolicy**

** **

**At the present time, the Company has not issuedpreferred stock. **The Company has notdeclared or paid dividends on its common stock to date, and does not anticipatepaying dividends in the foreseeable future. Any dividends declared would be subject to the prior rights of holdersof any outstanding cumulative preferred stock. CertainCompany loan documents restrict the payment of dividends.

** **

**EquityCompensation Plans**

** **

The followingtable sets forth certain information regarding the Company’s equitycompensation plans as of December 31, 2004:

** **
| **Plan Category**                                           | ** ** | **Number of securities to be   issued upon exercise of  outstanding options,  warrants and rights  (a)** | ** ** | **Weighted average  exercise  price of outstanding  options, warrants and  rights  (b)** | ** ** | **Number of securities  remaining available for  future issuance under  equity compensation  plans (excluding  securities reflected in  column (a))  (c)** | ** ** |
|-------------------------------------------------------------|------------|----------------------------------------------------------------------------------------------------------|------------|------------------------------------------------------------------------------------------|------------|------------------------------------------------------------------------------------------------------------------------------------------------------------|------------|
| Equity compensation plans approved by  security holders     |       | —                                                                                                   |       | —                                                                                   |       | 968,559                                                                                                                                                    |       |
| Equity compensation plans not approved by  security holders |       | —                                                                                                   |       | —                                                                                   |       | —                                                                                                                                                     |       |
| Total                                                       |       | —                                                                                                   |       | —                                                                                   |       | 968,559                                                                                                                                                    |       |

 

9

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**ITEM 6. SELECTED FINANCIAL DATA**

 

**SELECTED CONSOLIDATEDFINANCIAL DATA**

** **

**The following table sets forth selectedconsolidated financial statement information for the years ended December 31,2004, 2003 and 2002, nine months ended December 31, 2001 and 2000, and the yearended March 31, 2001.  The followingselected consolidated financial data should be read in conjunction with Item 7,“Management’s Discussion and Analysis of Financial Condition and Results ofOperations” and Item 8, “Financial Statements and Supplementary Data.”**

** **
| ** **                                                       | ** ** | **YEARS ENDED DECEMBER 31,** | ** ** | **NINE MONTHS ENDED  DECEMBER 31,** | ** ** | **YEAR  ENDED  MARCH 31,** | ** ** |
|------------------------------------------------------------------|------------|------------------------------|------------|-------------------------------------|------------|----------------------------|------------|
| ** **                                                       | ** ** | **2004**                     | ** ** | **2003**                            | ** ** | **2002**                   | ** ** | **2001 (1)** | ** ** | **2000** | ** ** | **2001** | ** ** |
| ** **                                                       | ** ** | ** **                   | ** ** | ** **                          | ** ** | ** **                 | ** ** | **(UNAUDITED****)** | ** ** |
| ** **                                                       | ** ** | **(Thousands of dollars)**   | ** ** |
| **CONSOLIDATED STATEMENTS OF OPERATIONS DATA:**                  |       |                         |       |                                |       |                       |       |   |   |   |   |   |   |
| ** **                                                       |       |                         |       |                                |       |                       |       |   |   |   |   |   |   |
| Operating revenues                                               |       | $                            | 82,624     |                                | $          | 82,844                     |       | $ | 74,637 |   | $ | 53,122 |   | $ | 52,100 |   | $ | 72,465 |   |
| Operating expenses                                               |       | (72,405                      | )          | (61,910                             | )          | (58,307                    | )          | (43,142 | ) | (50,101 | ) | (68,144 | ) |
| Operating income                                                 |       | 10,219                       |       | 20,934                              |       | 16,330                     |       | 9,980 |   | 1,999 |   | 4,321 |   |
| Other income (expense) (2)                                       |       | (6,926                       | )          | (7,599                              | )          | (7,140                     | )          | (5,550 | ) | (5,915 | ) | (8,502 | ) |
| Income (loss) before income taxes                                |       | 3,293                        |       | 13,335                              |       | 9,190                      |       | 4,430 |   | 3,916 |   | (4,181 | ) |
| Income tax (expense) benefit (3)                                 |       | 2,140                        |       | (2,137                              | )          | (414                       | )          | — |   | — |   | — |   |
| Net income (loss)                                                |       | $                            | 5,433      |                                | $          | 11,198                     |       | $ | 8,776 |   | $ | 4,430 |   | $ | (3,916 | ) | $ | (4,181 | ) |
|                                                             |       |                         |       |                                |       |                       |       |   |   |   |   |   |   |
| **NET INCOME PER COMMON SHARE:**                                 |       |                         |       |                                |       |                       |       |   |   |   |   |   |   |
|                                                             |       |                         |       |                                |       |                       |       |   |   |   |   |   |   |
| Basic                                                            |       | $                            | 3.51       |                                | $          | 7.69                       |       | $ | 6.74 |   |   |   |   |   |   |   |
| Diluted                                                          |       | $                            | 3.40       |                                | $          | 7.41                       |       | $ | 6.74 |   |   |   |   |   |   |   |
|                                                             |       |                         |       |                                |       |                       |       |   |   |   |   |   |   |
| **WEIGHTED AVERAGE NUMBER OF COMMON SHARES  OUTSTANDING:**       |       |                         |       |                                |       |                       |       |   |   |   |   |   |   |
|                                                             |       |                         |       |                                |       |                       |       |   |   |   |   |   |   |
| Basic                                                            |       | 1,546,271                    |       | 1,455,443                           |       | 1,302,355                  |       |   |   |   |   |   |   |
| Diluted                                                          |       | 1,596,796                    |       | 1,510,741                           |       | 1,302,355                  |       |   |   |   |   |   |   |
|                                                             |       |                         |       |                                |       |                       |       |   |   |   |   |   |   |
| **PRO FORMA BASIC AND DILUTED EARNINGS PER  SHARE (UNAUDITED):** |       |                         |       |                                |       |                       |       |   |   |   |   |   |   |
|                                                             |       |                         |       |                                |       |                       |       |   |   |   |   |   |   |
| Net income (loss)                                                |       |                         |       |                                |       |                       |       | $ | 3.40 |   |   |   | $ | (3.21 | ) |
| Pro forma shares outstanding                                     |       |                         |       |                                |       |                       |       | 1,302,355 |   |   |   | 1,302,355 |   |

 
| ** **                           | ** ** | **DECEMBER 31,**           | ** ** | **MARCH 31,** | ** ** |
|--------------------------------------|------------|----------------------------|------------|---------------|------------|
| ** **                           | ** ** | **2004**                   | ** ** | **2003**      | ** ** | **2002** | ** ** | **2001 (2)** | ** ** | **2000** | ** ** | **2001** | ** ** |
| ** **                           | ** ** | ** **                 | ** ** | ** **    | ** ** | ** ** | ** ** | **(UNAUDITED****)** | ** ** |
| ** **                           | ** ** | **(Thousands of dollars)** | ** ** |
| **CONSOLIDATED BALANCE SHEET DATA:** | ** ** | ** **                 | ** ** |
| ** **                           | ** ** | ** **                 | ** ** |
| Utility plant                        |       | $                          | 149,361    |          | $          | 152,162 |   | $ | 156,517 |   | $ | 164,547 |   | $ | 170,111 |   | $ | 168,920 |   |
| Total assets                         |       | 199,687                    |       | 202,989       |       | 211,294 |   | 214,459 |   | 218,382 |   | 221,195 |   |
| Long-term debt, net                  |       | 134,032                    |       | 143,372       |       | 148,052 |   | 181,732 |   | 184,688 |   | 188,627 |   |
| Equity and margins                   |       |                       |       |          |       |   |   | 7,672 |   | 6,012 |   | 5,675 |   |
| Stockholders’ equity            |       | 35,352                     |       | 26,973        |       | 14,738 |   |   |   |   |   |   |   |
|                                      |            |                            |            |               |            |  |  |  |  |  |  |  |  |  |  |  |  |  |  |

 

----

**(1)**                                  The Company changed its year-end from March 31to December 31, effective December 31, 2001.

 

10

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**(2)**           Includes $1,357,000 of impaired costs related to the LamarCombination for the year ended December 31, 2002.  See Note 4 to the consolidated financialstatements.

**(3)**           Upon conversion to a shareholder owned corporation, theactivities and transactions of the parent became taxable.

** **

**ITEM 7.**         MANAGEMENT’S DISCUSSION AND ANALYSIS OFFINANCIAL CONDITION AND RESULTS OF OPERATIONS

** **

**Cautionary Statement RegardingForward-Looking Statements**

** **

**Certain written and oral statements made by ourCompany or with the approval of an authorized executive officer of our Companymay constitute “forward-looking statements” as defined under the PrivateSecurities Litigation Reform Act of 1995, including statements set forth inthis Form 10-K as they relate to Management’s future plans and objectives, andin other filings with the Securities and Exchange Commission.  Generally the words “may,” “will,” “expect,” ‘intend,”“project,” “estimate,” “anticipate,” “believe,” or “continue” or the negativethereof and similar terminology identify forward-looking statements, whichgenerally are not historical in nature.**

** **

**All statements other than statements ofhistorical facts included in this report, including, without limitation,statements regarding the Company’s future financial position, businessstrategy, budgets, growth, sales projected costs and plans and objectives ofManagement for future operations, are forward-looking statements.   Forward-looking statements are subject tocertain risks and uncertainties that could cause actual results to differmaterially from our Company’s historical experience and our presentexpectations or projections.  As and whenmade, management believes that these forward-looking statements arereasonable.  However, caution should betaken not to place undue reliance on any such forward-looking statements sincesuch statements speak only as of the date when made.  There can be no assurances that any of theseexpectations will prove correct or that any of the actions that are plannedwill be taken.  The Company undertakes noobligation to publicly update or revise any forward-looking statements, whetheras a result of new information, future events or otherwise.**

** **

**The following are some of the factors thatcould cause our Company’s actual results to differ materially from the Companyexpectations described in or underlying our Company’s forward-lookingstatements:**

** **

**•**                  Weather conditions could affect our electricity sales andrevenues;

**•**                  Change in rate structure and ability to earn a fair returnon our rate base and recover the costs of operations could affect ouroperations.  A negative outcome in ourcurrent rate proceeding could affect our Company’s profits;

**•**                  Federal and state regulatory actions, and associated legaland administrative proceedings, especially as they relate to the oversightauthority of the Public Utility Commission of Texas could affect revenues andearnings and could cause us to lose customers through Increased competition inthe electric utility industry;

**•**                  Demands for electric power and the associated costs,including changes in the costs of power plant fuels such as natural gas andcoal could cause our purchased power cost to increase, which could in turnaffect our customers’ useage and our revenues;

**•**                  Changes in the Company’s cash position and availability ofcapital resources;

**•**                  The impact of changes in interest rates;

**•**                  Changes in federal and state tax laws;

**•**                  Unexpected changes in operating expenses and capital expenditures.

** **

**All subsequent written and oral forward-lookingstatements attributable to the Company, or persons acting on its behalf, areexpressly qualified in their entirety by the Cautionary Statements.  The Company assumes no duty to update orrevise its forward-looking statements based on changes in internal estimates orexpectations.**

** **

**The following discussion and analysis of theCompany and its Predecessor’s financial condition and results of operations forthe years ended December 31, 2004, 2003, and 2002 should be read in conjunctionwith the**

 

11

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**Company’s audited consolidated financialstatements and related notes to financial statements included elsewhere in thisdocument.  Unless otherwise indicated,all references to the Company will include any and all activities of itsPredecessor.**

** **

**Overview**

** **

**Cap Rock Energy Corporation is an electricdistribution company operating in various noncontiguous areas in the State ofTexas. The Company provides service to over 33,500 meters in 28 countiescovering approximately 13,000 square miles in Texas. This includes 23,000meters within two operating divisions in the Midland-Stanton area of westTexas, 6,200 meters in the central Texas area around Brady,  and over 4,300 meters in   northeast Texas in Hunt, Collin and FanninCounties. The Company also provides management services to the FarmersvilleMunicipal Electric System which services nearly 1,500 meters in Farmersville,Texas.**

** **

**The Company purchases power from wholesalesuppliers and distributes that power to its retail customers over transmissionlines covering over 305 miles and then over 11,000 miles of distribution lines.The Company’s primary focus is on the distribution of electricity to itscustomers, and therefore has not and does not plan to engage in the generationof electricity.  In 2003, the Companypurchased all electric power pursuant to wholesale electric power contractswith three suppliers.  Generally, thewholesale electric power supply contracts are based on fixed charges for kWhusage, transportation and auxiliary services and a variable charge for fuelbased on kWh usage. The Company’s purchased power costs fluctuate primarilywith the price of fuel used to generate that electricity, which is primarilynatural gas and coal. However, all costs associated with purchased power arepassed through to the retail customer.**

** **

**EffectiveSeptember 1, 2003, the Company became subject to the oversight authority of thePUCT, and the rates and fees charged to customers by the Company are nowsubject to PUCT approval.  In accordancewith this change, the Company filed its tariff for electric service with thePUCT.  The Company was also required tosubmit a standard rate filing package to the PUCT in late February 2004, inconnection an inquiry instituted by the PUCT to determine the reasonableness ofthe Company’s electric rates.  Thisfiling contained a request for a rate increase for some customer classes.  A hearing was held in October 2004 regardingthe Company’s rate filing package and a final decision is expected in thesecond quarter of 2005.  A hearing willbe held in April 2005, to determine if the tariffs filed by the Company are theactual tariffs that were approved by the Company’s Board of Directors, whichwas the Company’s previous regulatory authority.  The Company believes the issue is mootbecause any current tariff will be superseded by the tariff that is ultimatelyapproved by the PUCT in the current rate case. A total of $3,593,000 in third party costs were incurred to prepare therate filing package, as well as the public hearing process.  The amount and period over which the Companywill be allowed to recover these costs will be determined by the PUCT.**

** **

**At September 30, 2003, the Company had a notepayable to a bank for $11,675,000 which was cross-collateralized by notesreceivable from United Fuel and Energy Corporation (“United Fuel”) in the sameamount.  In October 2003, United Fuelconsummated financing with a lender that provided for funds to partially paydown the Company’s note payable to a bank, with United Fuel taking the positionas borrower on the Company’s note payable to a bank, thus extinguishing UnitedFuel’s note receivable to the Company. The Company was a secondary guarantor for United Fuel’s note, and wasrequired to record a guarantee obligation based on fair value.  When United Fuel repaid the note to the bankin November 2004, the Company’s obligation as guarantor was effectivelyreleased and it was able to eliminate the recorded $35,000 guarantorobligation.**

** **

**In March 2004, the Company signed an agreementwith a shareholder of United Fuel to sell the Company’s shares of stock inUnited Fuel at a sales price of $1,300,000, in exchange for a note receivablefrom that shareholder.  The terms of theagreement provide for repayment after United Fuel has completed certaincapitalization arrangements.  Allconditions required pursuant to the agreement have been satisfied, and theCompany expects payment as scheduled in 2005. Recognition of the gain of $940,000 has been deferred until principalpayments have been received.**

 

12

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**The financing arrangements with Beal Bankprovided for an initial and an additional advance.  The Company drew the initial advance inSeptember 2003.  A collateralized cashinvestment was used to repay the initial advance of $14,169,000 in November2004.**

** **

**Critical Accounting Policies and Estimates**

 

TheCompany’s significant accounting policies are described in Note 1 to theconsolidated financial statements. Certain of our accounting policies require the application ofsignificant judgment by Management in selecting the appropriate assumptions forcalculating financial estimates.  Bytheir nature, these judgments and estimates are subject to an inherent degreeof uncertainty.  These judgments andestimates are based on our historical experience, terms of existing contracts,our observance of trends in the industry, information provided by ourcustomers, and information available from other outside sources asappropriate.  Different estimatesreasonably could have been used in the current period, or changes in theaccounting estimates are reasonably likely to occur from period to period, thatcould have a material impact on the presentation of the Company’s financialcondition, changes in financial condition or results of operations.  Management believes that the followingfinancial estimates are both important to the portrayal of the Company’sfinancial condition and results of operations and require subjective or complexjudgments.  Further, it is believed thatthe items discussed below are properly recorded in the financial statements forall periods presented.  Management hasdiscussed the development, selection and disclosure of the most criticalfinancial estimates with the Board of Directors’ Audit Committee.

 

***Rate Regulation****. *The Company’s most critical accounting policyinvolves rate regulation.  The Company issubject to the provisions of Statement of Financial Accounting Standards (“SFAS”)Statement No. 71, “Accounting for the Effects of Certain Types of Regulation.”  In certain circumstances, SFAS No. 71requires that certain costs and/or obligations be deferred on the balance sheetuntil matching revenues are recognized, subject to regulatory approval.  It is the Company’s policy to assess therecoverability of costs recognized as regulatory assets in accordance with SFASNo. 71, based on each regulatory action and the criteria set forth in SFAS No.71.  Any disallowance of these deferredcosts would be charged immediately against income upon that disallowance.

 

***Power Cost Recovery Factor****.*  The power cost recovery factor is thedifference between the cost of power purchased and the cost of power recoveredfrom customers, divided by the number of kilowatt hours billed during theperiod.  Power purchased includestransmission costs and wheeling charges. This factor is estimated each month to recover actual power costs and isadded  as a surcharge to the base rate.  The factor is based on estimates of powercost increases or decreases due to changes in fuel cost, usage and other costfluctuations.  The estimate is adjustedin the subsequent month as compared to actual activity.  The Company currently defers the differencebetween actual purchased cost and billed cost as a regulatory asset orliability.  The regulatory asset orliability, as well as the deferral, are adjusted accordingly by either receiptfrom, or refund to, the customer of the net deferred amount.

 

***Derivative Instruments and Hedging Activities****. *The Company may enterinto derivative transactions to manage the cost of natural gas as the fuelcomponent of power cost.  As described inNote 1 to the consolidated financial statements, the pricing under the Company’svarious power contracts varies with fuel cost, which is generally determined bythe cost of natural gas.  Derivativetransactions minimize the fluctuations in the Company’s customers’ powerbills.  These instruments are measured atfair market value and recorded as an asset or liability with a correspondingregulatory asset or liability.  Changesin the fair value are recognized in current earnings unless specific hedgeaccounting criteria are met.  As ofDecember 31, 2004 and 2003, no derivative positions were held.

 

***Revenue Recognition Policy****. *For all periods through December 31, 2002,the Company and its predecessor, the Cooperative, utilized the cycle billingmethod to recognize revenue, pursuant to the rate-making policy as set by the Boardof Directors.  The cycle billing methodrecognizes revenue on an “as billed basis” when the customer is billed and not on an accrual basis, whichrecognized revenue as the power is distributed to the customer.  By utilizing the “as billed” method, unbilledrevenue was not recognized.

 

13

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EffectiveJanuary 1, 2003, the Company’s Board of Directors changed the rate-makingpolicy to recognize unbilled revenue. The Company was then required to change accounting principles related toits revenue recognition method.  Underthe new rate-making structure, the Company recognizes revenue when power isdistributed to the customer, rather than when the customer is billed.

 

***Stock Based Compensation.*** Effective January 1, 2003, the Company adoptedthe fair value method of accounting for its employee stock incentive plan inaccordance with SFAS No. 123, “Accounting for Stock-Based Compensation,” asamended by SFAS No. 148, “Accounting for Stock-Based Compensation, Transitionand Disclosure.”

** **

***Tax Liabilities and Valuation of DeferredTax Assets.**** *The Company is required to assess the ultimate realizationof deferred tax assets generated from net operating losses, and capital lossesincurred on the sale of assets.  This assessmenttakes into consideration tax planning strategies within our control, includingassumptions regarding the availability and character of future taxableincome.  At December 31, 2004 and 2003,the Company has recorded $3,285,000  and$8,074,000 of valuation allowances against net deferred tax assets forwhich  the ultimate realization of thetax asset is mainly dependent on the availability of future taxableincome.  The ultimate amount of deferredtax assets realized could be materially different from that recorded, asimpacted by changes in federal income tax laws to enable us to realize therelated tax assets.

** **

**At December 31, 2004 and 2003, there wereapproximately $25,630,000 and $20,800,000 of net operating loss carryforwardsthat expire in 2009 through 2024, and may be used to offset future taxableincome.  The Company recorded valuationallowances against the deferred tax assets related to net operatinglosses.  This determination was based onthe assessment that it is more likely than not that the Company may not be ableto realize these deferred assets during the carryforward period.  This assessment considered the forecastreversal of existing temporary differences and taxable income expected to begenerated in the carryforward period.**

** **

***Impairment of Long-lived Assets.**** *Management reviews the carrying value of long-lived assetswhenever events or changes in circumstances indicate that such carrying valuesmay not be recoverable in accordance with Statement of Financial AccountingStandards No. 144, “Accounting for the Impairment or Disposal of Long-livedAssets.”  Unforeseen events and changesin conditions could indicate that these carrying values may not be recoverableand may therefore result in impairment charges. An impairment loss is recognized only if the carrying amount of thelong-lived asset is not recoverable and exceeds its fair value.  The carrying amount of a long-lived asset isnot recoverable if it exceeds its future undiscounted cash flows, and ifrequired, fair value of long-lived asset is written down to its fairvalue.  The determination of future cashflows, and if required, fair value of long-lived asset is by its nature ahighly subjective judgment.  Fair valueis determined by calculating the discounted future cash flows using a discountrate, third party contracted bids or appraisals performed by a qualifiedparty.  Significant judgments andassumptions are required in the forecast of future operating results used inthe preparation of the long-term estimated cash flows, including long-termforecasts of the amounts and timing of overall market growth.  Changes in these estimates could have amaterial effect on the assessment of our long-lived assets.

** **

***Postretirement Healthcare Benefits.**** *The Company provides certain postretirement healthcarebenefits to employees and retirees. Determining the costs associated with such benefit is dependent onvarious actuarial assumptions including demographics (age, sex), mortalityrates, discount rates used in determining the projected benefit obligations,and current and projected health care cost trend rates.  Independent actuaries perform the requiredcalculations, in accordance with accounting principles generally accepted inthe United States.  Actual results thatdiffer from the actuarial assumptions are generally accumulated and amortizedover future periods.

 

14

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**Results of Operations**

** **
| ** **               | ** ** | **Year Ended December 31,** | ** ** |
|--------------------------|------------|-----------------------------|------------|
| ** **               | ** ** | **2004**                    | ** ** | **2003** | ** ** | **2002** | ** ** |
| ** **               | ** ** | **(Thousands of dollars)**  | ** ** |
| **Operating Revenues:**  |       |                        |       |   |   |   |   |
| Electric revenues        |       | $                           | 81,149     |   | $ | 81,402 |   | $ | 73,335 |   |
| Other                    |       | 1,475                       |       | 1,442 |   | 1,302 |   |
| Total operating revenues |       | $                           | 82,624     |   | $ | 82,844 |   | $ | 74,637 |   |

 

Theconsumption and demand for electricity within the Company’s service areas isgreatly impacted by weather conditions and temperatures.  The hot temperatures during the summermonths, or the third quarter, require residential customers to use moreelectricity in cooling their homes. Rural customers who irrigate crops use more electricity in the summer monthsfor the irrigation process, and if the spring season didn’t bring much rain,these customers may irrigate sooner and longer. Portions of the Company’s service areas had been experiencing a severelong-term drought, but these conditions are much less severe than in the past.

 

Althoughelectric revenues decreased only $253,000 between 2003 and 2004, the aggregatecomponents were:

 

•                  An increase in power cost recovery of$2,702,000;

•                  Increase in wholesale sales and kWh sales of$801,000;

•                  A decrease in 2004 of $3,755,000 as a resultof the 2003 change in accounting principle.

 

Theincrease in power cost recovery is comprised of the increase of  the pass through of fuel costs to customersof $4,150,000, and a decrease in the amount of revenue recognition related to aregulatory surcharge authorized by the Board of Directors of $1,448,000.  It was intended to recover some of theexpense incurred in connection with the Company’s response to OpposingIntervenors actions in the CCN case.  Atotal of $2,354,000 was billed to customers from June 2003 through February2004; $92,000 was recognized as revenue in 2004, $1,539,000 was recognized asrevenue in 2003, and the remainder of $723,000 is shown as a regulatoryliability on the balance sheet at December 31, 2004.

 

Electricrevenues increased $8,067,000 for 2003 as compared to 2002.  This rise is due to multiple factors:

 

•                  An increase of $4,600,000 for recovery ofpower costs;

•                  An increase in revenue accruals of $3,400,000due to the effect of the change in accounting principle in 2003.

 

TheCompany had been realizing deferred revenue of $4,364,000 equally over a 24month period from January 2002 to December 2003.  This revenue was recognized equally in boththe 2003 and 2002 periods, and was billed through the power cost recoveryfactor, and is not being reflected in any future periods.  This item related to purchased power that wasexpensed in prior years.

 

Because of achange in the Public Utility Regulatory Act (“PURA”), as of September 1, 2003,the Company’s ratesbecame subject to regulation and approval by the PUCT, not the Company’s Boardof Directors.   In accordance with thischange in the PURA, the Company filed its tariffs for electric service onSeptember 2, 2003.  The staff of the PUCTreviewed those tariffs and provided comments and proposed changes to bring thetariffs into compliance with PUCT rules and regulations.  Because the tariffs, when adopted, were notsubject to PUCT regulation, some of the provisions did not comply with PUCTrules and regulations since that was not a requirement when the tariffs wereadopted.  Now that the Company is subjectto PUCT regulation, the Company made proposed amendments to its tariff assuggested by the PUCT staff.  The PUCTstaff reviewed the proposed changes and recommended that the tariff beapproved.  Prior to the AdministrativeLaw Judge entering a ruling approving the tariff, with the proposed changes,several of the group of intervenors in the case were successful in obtaining alegislative request that the matter be referred to the State Office ofAdministrative Hearings (“SOAH”)

 

15

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fora hearing on the merits.  As a result,the matter was referred to SOAH and a hearing is currently scheduled for April,2005.  The hearing will be limited towhether the tariffs filed by the Company are the actual tariffs that wereproperly approved by the Company’s Board of Directors, which was the Company’sprevious regulatory authority.  TheCompany believes the issue is moot because any current tariff will besuperseded by the tariff that is ultimately approved by the PUCT in the currentrate case.

 

InOctober 2004, the PUCT initiated an inquiry to determine the reasonableness ofthe Company’s rates and ordered the Company to submit a rate filingpackage.  The Company prepared and fileda rate filing package that contained a request for a rate increase for somecustomer classes.  The Company initiallyrequested a $6,333,000 overall annual after tax increase but due to adjustmentsmade while preparing for the hearing on the merits in the case, that amount wasadjusted downward to $5,021,000. Hearings were held before the State Office of Administrative Hearingsfrom October 5, 2004, through October 14, 2004. During such hearings, the Company presented testimony and evidence insupport of its requested rate increase. Numerous intervening parties and the PUCT staff presented evidence andtestimony in opposition to the rate increase and in support of a ratedecrease.  The parties have filed briefsin support of their positions.  TheCompany has agreed to extend the effective date for the requested rate increaseuntil June 17, 2005.  A hearing was heldin December 2004, to determine the amount of rate case costs that the PUCT willallow the Company to recover from its customers, as well as the period ofrecovery.  The Company believes all itsrate case costs are reasonable and necessary and should be recoverable.  Any amount not allowed for recovery will beexpensed immediately.  As of December 31,2004, $3,593,000 of third party costs had been incurred in connection with therate case, and are shown on the balance sheet as a regulatory asset.   These costs were deferred pending approvalof recovery by the PUCT.  See also Note 11to the consolidated financial statements.

 

**OnMarch 17, 2005, the Administrative Law Judges (“ALJ’s”) issued a Proposal forDecision (“PFD”).  The PFD recommended a7.49% rate decrease for Cap Rock.  Thisamounts to an annual revenue decrease of approximately five milliondollars.  Several intervenors had soughtrate decreases which were much larger than the recommendation of the ALJ’s.  A final ruling, which can be appealed by CapRock or any of the intervenors, is expected by June 2005.**

** **

**TheCompany feels that its rates and its requested rate increase are justified andthat the evidence supports that.  TheCompany will request that the PUCT reject the recommendation of the ALJ’s andgrant its requested rate increase.  TheCompany has received recommendations from Administrative Law Judges in the pastwhich were not in its favor, only to prevail when the issues were considered bythe PUCT.  The Company believes its ratesare reasonable and that the requested rate increase is appropriate based uponits cost of service and reasonable return on its rate base.  However, the Company cannot determine whataction the PUCT will take with respect to the PFD.**

** **

Ifthe Company’s request for a rate increase is approved by the PUCT, the Companymay suffer a decline in its customer base. Because the outcome of the rate request or rate order is unknown, theCompany is unable to predict the effect of such order.

 
| ** **                    | ** ** | **Year Ended December 31,** | ** ** |
|-------------------------------|------------|-----------------------------|------------|
| ** **                    | ** ** | **2004**                    | ** ** | **2003** | ** ** | **2002** | ** ** |
| ** **                    | ** ** | **(Thousands of dollars)**  | ** ** |
| **Operating Expenses:**       |       |                        |       |   |   |   |   |
| Purchased power               |       | $                           | 40,032     |   | $ | 36,578 |   | $ | 36,433 |   |
| Operations and maintenance    |       | 10,331                      |       | 10,135 |   | 7,327 |   |
| General and administrative    |       | 7,518                       |       | 4,639 |   | 7,144 |   |
| Stock compensation            |       | 4,925                       |       | 2,133 |   | — |   |
| Depreciation and amortization |       | 7,416                       |       | 6,719 |   | 5,834 |   |
| Property taxes                |       | 1,925                       |       | 1,345 |   | 1,367 |   |
| Other                         |       | 258                         |       | 326 |   | 202 |   |
| Total  operating expenses     |       | $                           | 72,405     |   | $ | 61,875 |   | $ | 58,307 |   |

 

16

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Purchasedpower expense normally moves in relation to electric demand and consumption.  Contract terms with wholesale power suppliersprovide for pricing based upon the price of fuel, demand and usage.  All costs of power are passed through to theCompany’s retail customers.

 

Purchasedpower increased $3,454,000 from 2003 to 2004. The net changes related to:

 

•                  Increase in fuel cost related to theregulatory liability due to overcollection of power cost recovery of$3,074,000;

•                  Increase in power costs of $4,754,000;

•                  Decrease of $4,412,000 in 2004 because of theconclusion in 2003 of the rate making treatment of the capital lease paymentsassociated with the transmission system.

 

Purchasedpower only increased by $145,000 from 2002 to 2003.  The net change is attributable to:

 

•                  An increase in power costs of $2,966,000which includes $1,318,000 of power cost lag because of the change to theaccrual method of accounting;

•                  A conclusion in September 2003 to the ratemaking treatment of the capital lease payments which were associated with thetransmission system.  This caused adecrease of $2,773,000.

 

Thecost of natural gas has risen from 2002 to 2004, which increased the cost ofpurchased power and is passed directly through to customers.

 

Rate-makingtreatment required the Company to classify the amortization of property andequipment under the capital lease, as well as the associated interest expense,as purchased power.  Because the leasewas extinguished in September 2003, the treatment is no longer applicable, andthe remaining net book value of the transmission system is being depreciatedover its remaining life, and that expense is reflected in Depreciation andAmortization expense.

 

Factorsaffecting operations and maintenance expense are certain weather conditionssuch as high winds, ice storms and lightning which cause damage to electriclines and interrupt service.  Operationsand maintenance increased $196,000 and $2,808,000, respectively, between 2004and 2003, and 2003 and 2002.  Themajority of the change is related to an increased need in maintenance for thedistribution and transmission systems which resulted in current expense, asopposed to engaging in construction activities that would have resulted incapitalized costs.

 

Generaland administrative expenses increased by $2,879,000 from 2003 to 2004, becauseof the following:

 

•                  Increased costs in 2004 of $1,610,000 relatedto IT support and outsourced IT functions;

•                  Increased expenditures of $218,000 associatedwith public relations;

•                  Decreased overhead allocation from 2003 to2004 to utility plant and operations and maintenance of $890,000 resulted inhigher costs remaining in general and administrative.

 

Generaland administrative expenses decreased by $2,505,000 between 2002 and 2003,because of  decreases in legal andprofessional fees, the majority of which were associated with the PUCTproceedings concerning the application to transfer the Cooperative’s certifiedterritory to the Company, as well as decreases in public reporting costs.

 

TheCompany expects regular general and administrative expenses to increase in thefuture because compliance with PUCT rules and regulations, as well as theSarbanes Oxley Act of 2002, will require more resources and personnel.

 

InDecember 2002, the shareholders approved the Stock Incentive Plan whichauthorized a total of 800,000 shares under that plan.  See “Equity Compensation Plans” under Item5.  In April 2003, each employee wasgranted a noncash stock award, with vesting over 5 years.  Officers, directors and certain retireddirectors were also granted noncash stock awards in July 2003, with vestingperiods ranging from 2 to 5 years.  Bothawards

 

17

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arebeing amortized to expense over periods of 2 to 5 years, with the expensereflecting the fair value of the award.

 

InDecember 2004, an additional award of stock was granted to employees, officersand directors.  Employee awards vest overtwo years, and officers’ and directors’ awards vested immediately.  The fair value of this award is beingamortized to expense over the applicable vesting period.  Expected noncash compensation expense by yearfor all awards is as follows: 2005 - $1,225,000, 2006 - $324,000, 2007 -$316,000 and 2008 - $108,000.

 

Depreciationand amortization increased $662,000 from 2003 to 2004 because of the followingfactors:

 

•                  Conclusion in 2003 of the rate makingtreatment of the amortization of property and equipment associated with thetransmission system capital lease caused an increase of $412,000 because thetreatment is no longer applicable;

•                  Amortization in 2004 of $367,000 relative tothe capitalized costs of the IT system.

 

Depreciationand amortization increased $920,000 from the year ended 2002 as compared to2003 for various reasons:

 

•                  Increased depreciation expense of $359,000associated with changes in estimated useful lives of certain general plantassets;

•                  Conclusion of the rate making treatment ofthe amortization of property and equipment associated with the transmissionsystem capital lease caused an increase of $220,000.

 

Inconnection with the original ten year capital lease associated with thetransmission system, generally accepted accounting principles required theCompany to amortize the asset over a period consistent with the leasepayments.  This period was much shorterthan the estimated life of the asset, and the amortization was charged topurchased power.  Because the capitallease was extinguished in September 2003, and the rate-making treatment is nolonger applicable, the method of depreciation and life of the transmissionsystem assets has changed to a straight-line method with a 20 year remaininglife, and the expense is reflected in Depreciation and Amortizationexpense.  The Company estimates theamount of such depreciation on the transmission system to be $864,000 per year.

 

Inits efforts to be able to adapt to a changing regulatory environment, enhanceefficiency and automate certain processes, management recognized the need for amore sophisticated and responsive IT system and associated applications.  The Company engaged an outside third party toassess the Company’s current and future IT needs, assist in the selectionprocess of software and related applications, implement the chosen products andprocesses and provide ongoing support. The third party IT company is also assisting the Company in providing ITinternal control documentation and procedures related to compliance withSection 404 of the Sarbanes Oxley Act of 2002.

 

CertainIT costs associated with the change in the operating environment, the softwareapplications and implementation process have been capitalized.  These costs aggregated $4,486,000 and$3,881,000 at December 31, 2004 and 2003, and the Company began a 5 yearamortization period beginning March 2004, which was the end of the plannedimplementation.  In addition, the ongoingcosts for maintenance and IT support are based on the number of meters perrespective month and, based on the number of meters as of December 31, 2004,will approximate $1,697,000 per year through the term of the contract, which isDecember 2007.  All applications areanticipated to be operational by mid 2005.

 

Historically,property tax expense had remained relatively constant.  In 2004, such expenses increased $580,000because of current appraisal methodologies used in the ad valorem taxation ofinvestor owned utilities in Texas, as well as the Company’s revenue-generatingability, as compared to its former status as a cooperative.

 

18

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** **
| ** **                                          | ** ** | **Year Ended December 31,** | ** ** |
|-----------------------------------------------------|------------|-----------------------------|------------|
| ** **                                          | ** ** | **2004**                    | ** ** | **2003** | ** ** | **2002** | ** ** |
| ** **                                          | ** ** | **(Thousands of dollars)**  | ** ** |
| **Other Income (Expense):**                         |       |                        |       |   |   |   |   |
| Allocation of income from associated  organizations |       | $                           | 540        |   | $ | 530 |   | $ | 478 |   |
| Interest expense, net of capitalized  interest      |       | (7,983                      | )          | (8,012 | ) | (7,403 | ) |
| Interest and other income                           |       | 646                         |       | 795 |   | 1,027 |   |
| Impairment of Lamar combination costs               |       | —                      |       | — |   | (1,357 | ) |
| Loss on sale of MAP stock                           |       | —                      |       | (1,056 | ) | — |   |
| Equity earnings in MAP                              |       | —                      |       | 144 |   | 115 |   |
| Shareholders’ Trust                            |       | (129                        | )          | — |   | — |   |
| Total other  income (expense)                       |       | $                           | (6,926     | ) | $ | (7,599 | ) | $ | (7,140 | ) |

 

Interestexpense decreased $29,000 between 2003 and 2004 because of the following:

 

•                  Amortization of all remaining fees and costsincurred with respect to the Beal Bank loan caused an increase of $787,000;

•                  The initial Beal Bank advance was drawn on inSeptember 2003 and repaid in November 2004, with a resulting net increase of$795,000;

•                  The cross-collateralized note payable to abank was extinguished in September 2003 causing a decrease of $566,000 betweenthe periods;

•                  Interest expense on mortgage debt reflects adecrease of $126,000 because of the declining balance on the debt.

•                  In 2004, there was no amortization of thefees and costs associated with the original transmission system capital leasebecause the lease was extinguished in September 2003.  This caused a decrease of $984,000.

 

Interestexpense increased $609,000 between 2002 and 2003 because of the following:

 

•                  Increase of $478,000 because of the draw onthe initial advance from Beal Bank in September 2003 at a rate of 10.75% perannum;

•                  Initial amortization of $333,000 of the legalfees and costs in 2004 incurred with respect to consummation of the Beal Bankloan;

•                  Amortization of the fees and costs associatedwith the original transmission system capital lease were accelerated by$544,000, in order that these costs would be fully amortized by the end of thelease term;

•                  Decrease in interest on mortgage debt of$535,000 because the Company was able to lock in lower interest rates, coupledwith a declining principal balance;

•                  Decrease of $186,000 in interest associatedwith the cross-collateralized note payable to a bank because of its decliningbalance and it was extinguished in September 2003.

 

Asdescribed more fully in Note 22 to the consolidated financial statements, in1999 the Company entered into an agreement to combine with Lamar ElectricCooperative (“Lamar”).  Lamar terminatedthe agreement in late 2002.  Although theCompany is seeking to recover the costs and expenses incurred in connectionwith the combination, generally accepted accounting principles required theimpairment of those capitalized costs, which aggregated $1,357,000.

 

Becausethe investment in MAP was sold in 2003, the 2004 period will not reflect anytransactions related to MAP.

 

Whenthe Company and the Shareholders’ Trust entered into a Voting Agreement inDecember 2004, the Company recorded a long term liability based on fair valueof $129,000 and a corresponding expense. This

 

19

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wasfor consideration whereby the shares held by the Trust will be voted by theTrustees as directed by the Company for as long as the shares are held in theTrust.  See Note 21 to the consolidatedfinancial statements.

** **
| ** **                   | ** ** | **Year Ended December 31,** | ** ** |
|------------------------------|------------|-----------------------------|------------|
| ** **                   | ** ** | **2004**                    | ** ** | **2003** | ** ** | **2002** | ** ** |
| ** **                   | ** ** | **(Thousands of dollars)**  | ** ** |
| **Income Tax Expense:**      |       |                        |       |   |   |   |   |
| Income tax expense (benefit) |       | $                           | (2,140     | ) | $ | 2,137 |   | $ | 414 |   |
|                              |            |                             |            |  |  |  |  |  |  |  |

 

Incometax expense decreased $4,277,000 between 2003 and 2004, and increased $1,723,000between 2003 and 2002.  As of December31, 2004, the Company has net operating carryforwards of approximately $25.6million which are scheduled to expire in 2009 through 2024.  The Company has a valuation allowance of$3,285,000 against the net deferred tax asset. This valuation allowance decreased $4,789,000 from 2003 to 2004 in partbecause of a change in temporary differences and the resulting net deferredtaxes, and the changes in net operating losses between the two years.

 

Inearly 2004, the IRS notified the Company that it intended to examine thefederal income tax return of the Cooperative for the year 2001.  The Company and the IRS are in the finalstages of that process, and Management believes there will be no impact on theCompany’s financial position or results of operations.

 

**Contractual Obligations and Other Commitments**

** **

**The following table summarizes the Company’sobligations and commitments to make future payments under certain contractualobligations:**

** **
| ** **                            | ** ** | **2005**                   | ** ** | **2006** | ** ** | **2007** | ** ** | **2008** | ** ** | **2009** | ** ** | **Thereafter** | ** ** | **Total** | ** ** |
|---------------------------------------|------------|----------------------------|------------|----------|------------|----------|------------|----------|------------|----------|------------|----------------|------------|-----------|------------|
| ** **                            | ** ** | **(Thousands of dollars)** | ** ** |
| Debt obligations                      |       | $                          | 7,931      |     | $          | 4,210    |       | $        | 30,589     |     | $          | 3,935          |       | $         | 3,804      |   | $ | 93,285 |   | $ | 143,754 |   |
| Capital lease obligations             |       | 124                        |       | 72       |       | 31       |       | 17       |       | 17       |       | 25             |       | 283       |       |
| Operating lease obligations           |       | 485                        |       | 396      |       | 322      |       | 137      |       | 137      |       | 91             |       | 1,568     |       |
| Purchase obligations (1)              |       | 6,969                      |       | 2,099    |       | 2,099    |       | 402      |       | 402      |       | 2,802          |       | 14,773    |       |
| Other long term liabilities (2)(3)(4) |       | 1,543                      |       | 1,531    |       | 921      |       | 859      |       | 797      |       | 33,926         |       | 39,577    |       |
|                                       |            |                            |            |          |            |          |            |          |            |          |            |                |            |           |            |  |  |  |  |  |  |  |

 

----

(1)          All ofthe Company’s power contracts are firm, full requirements contracts.  These types of contracts require the Companyto purchase all of its power needs from the seller, but do not mandate aminimum purchase amount.  Therefore,amounts included for each year are basic required transmission charges.  Also included are commitments for IT servicesand certain professional services.

(2)          Includesactuarially calculated amounts for post retirement healthcare costs of$849,000, $838,000, $855,000, $827,000, and $776,000 for the years ended 2005,2006, 2007, 2008 and 2009, respectively, as well as $33,926,000 for the years2010 through 2050.

(3)          TheCompany has a contract with the City of Farmersville, Texas, to act as an agentto provide power, assume related billing and collections functions and isobligated to the City to make payments on a revenue sharing type basis.  The 2005, and estimated 2006, annual paymentsaggregate $621,000.

(4)          Paymentsto or benefits to be provided to advisory directors are included.

 

**Liquidity and Capital Resources**

** **

Asof December 31, 2004, the Company had:

 

•                  Cashand cash equivalents of $20,968,000;

•                  Workingcapital of $9,160,000; and

•                  Long-termindebtedness of $134,032,000, net of current portion.

 

20

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TheCompany requires capital to fund utility plant additions, working capital andother utility expenditures which are recovered in subsequent and future periodsthrough rates.  Capital necessary to meetthese cash requirements is now derived primarily from internally generatedfunds.

 

Includedin the $9,160,000 of working capital above, the Company has a $3.4 millionincome tax receivable.  $1.9 million ofthis receivable represents current year income tax overpayments, and $1.4million represents income taxes to be recovered through the carry back to prioryears of the Company’s current year net operating loss.  The Company should receive the $3.4 millionfederal income tax receivable during 2005.

 

Through2001, one of the Company’s primary sources of capital and liquidity had beenborrowings from the Company’s primary lender, National Rural Utilities CooperativeFinance Corporation (“CFC”). These borrowings are collateralized bysubstantially all of the Company’s utility distribution assets. The existinglong-term debt consists of a series of loans from CFC that impose variousrestrictive covenants, including the prohibition of additional securedindebtedness, or the guaranty of such, and requires the maintenance of a 1.35 debtservice coverage ratio as defined in the CFC loan agreements. In addition, theCompany may not make any cash distribution or any general cancellation orabatement of charges for electric energy or services to its customers if theratio of equity to total assets is less than a stated percentage. At December31, 2004, the Company was in compliance with its CFC loan agreements and theapplicable covenants.  See note 11 to theconsolidated financial statements for a discussion of CFC’s waivers related tothe prior conversion from a cooperative to a stock holder owned corporation.

 

**Substantiallyall of the CFC mortgage notes are subject to interest rate repricing at the endof various periods, at the Company’s option. The Company anticipates refinancing one of the mortgage notes that has aballoon payment of $26,367,000 due in 2007. Mortgage notes with CFC as of December 31, 2004, and the applicableinterest rates are as follows:**

** **
| **Interest Rate**   | ** ** | **Repricing in  January** | ** ** | **Amount** | ** **  |
|---------------------|------------|---------------------------|------------|------------|-------------|
|                |       |                      |       |       |        |   |   |
| Fixed               |       | 4.85                      | %          | 2006       |        | $ | 6,467,000 |   |
| Fixed               |       | 5.15                      | %          | 2007       |        | 64,055,000 |   |
| Fixed               |       | 4.70                      | %          | 2006       |        | 33,017,000 |   |
| Fixed               |       | 4.50                      | %          | 2007       |        | 5,960,000 |   |
| Fixed               |       | 4.30                      | %          | —     |        | 27,872,000 |   |
| Fixed               |       | 7.00                      | %          | —     |        | 2,000 |   |
| Fixed               |       | 4.20                      | %          | —     |        | 3,590,000 |   |
| Variable            |       | —                    |       | —     |        | 2,791,000 |   |
| Total mortgage debt |       |                      |       | $          | 143,754,000 |   |

 

FERCapproval was received in August 2003 for NewCorp to borrow $31,500,000 fromBeal Bank S.S.B. (“Beal Bank”).  Theinitial advance of $14,169,000 was used for payment of the balloon payment onthe transmission system capital lease in September 2003.  Simultaneously, the sinking fund of$8,207,000 was released by the lessee, and used to partially fund a restrictedsecurities account of $14,169,000, which was the only asset collateralized byBeal Bank.

 

Intereston the Beal Bank loan was 10.75%, payable monthly.  The financing arrangement provided for acommitment fee, which totaled $457,000 for the initial advance.  Additional amounts paid to Beal Bank werereimbursement of expenses, attorney fees, appraisals and consulting, which atDecember 31, 2004, aggregated $1,184,000. Prepayment of the initial advance was not allowed unless the additionaladvance was funded before the September 9, 2004, original due date.  Two amendments to the financing agreementextended the due date of the initial advance, and the collateralized securitiesaccount was then used to repay the initial advance in November 2004.  In the accompanying consolidated balancesheet at December 31, 2003, the initial advance of $14,169,000 is shown incurrent liabilities because it was not certain that the Company would draw onthe additional advance from Beal Bank.

 

**Stock awards were made to employees, officersand directors in both 2004 and 2003. Noncash compensation expense of $4,925,000 and $2,135,000 was recordedfor 2004 and 2003, because the fair value of the award is**

 

21

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**being amortized over each of the applicablevesting periods.  Expected noncashcompensation expense by year is as follows: 2005 - $1,225,000, 2006 - $324,000, 2007 - $316,000 and 2008 - $108,000.**

** **

**The terms of the note receivable agreement withthe shareholder of United Fuel provide for repayment after United Fuel hascompleted certain capitalization arrangements.  All conditions required pursuant to the agreement have been satisfied,and the Company expects full payment of the $1,300,000 in 2005.**

** **

**When the Company and the Cap Rock EnergyShareholders’ Trust entered into a Voting Agreement in December 2004, theCompany recorded a long term liability based on fair value of $129,000 and acorresponding expense.  This was forconsideration whereby the shares held by the Trust will be voted by theTrustees but as directed by the Company for as long as the shares are held inthe Trust.  This liability will be paidout as the owners of the shares are located and the shares are issued to theowner or their heirs.  Therefore, thisliability will be paid over future years, and is not expected to require amaterial amount of cash in any one year. See Note 21 to the consolidated financial statements.**

** **

**TheCompany provides continued major medical coverage to retired employees andtheir dependents.  The actuariallycalculated estimates of costs for future years is shown in the table under “ContractualObligations and Other Commitments.”  Aone percentage point change in assumed health care cost trend rates would havethe following effects:**

** **
| ** **                                                | ** ** | **One Percentage  Point** | ** ** |
|-----------------------------------------------------------|------------|---------------------------|------------|
| ** **                                                | ** ** | **Increase**              | ** ** | **Decrease** | ** ** |
| Effect on total of  service cost and interest cost        |       | $                         | 133        |   | $ | (105 | ) |
| Effect on accumulated  post retirement benefit obligation |       | 1,392                     |       | (1,136 | ) |
|                                                           |            |                           |            |  |  |  |  |

** **

**Although the outcome concerning the PUCT’sfinal order on the Company’s retail rates are unknown, with the current workingcapital position and the availability of other capital, Management feels theCompany has adequate resources to meet its obligations for 2005, includingthose enumerated in the table under “Contractual Obligations and OtherCommitments.”**

** **

**NewAccounting Standards**

** **

In December2004, the FASB issued SFAS No. 123R, “Share-Based Payment.”  SFAS No. 123R revises SFAS No. 123, “Accountingfor Stock-Based Compensation.”  This newstandard generally requires the cost associated with employee servicesreceived  in exchange for an award ofequity instruments be measured based on the grant-date fair value of the awardand recognized in the financial statements over the period during which theemployee is required to provide services in exchange for the award.  SFAS No. 123R also provides guidance on howto determine the grant-date fair value for awards of equity instruments, aswell as alternative methods of adopting its requirements.  SFAS No. 123R is effective as of thebeginning of the first interim or annual reporting period after June 15, 2005,and applies to all outstanding and unvested share-based payment awards at acompany’s adoption date.  The Companychanged its method of accounting from the intrinsic method per APB Opinion No.25, to the fair value method per SFAS No. 148, effective January 1, 2003.  Therefore, SFAS No. 123R is not expected tohave an impact on the Company’s consolidated financial statements.

 

In May 2004, theFinancial Accounting Standards Board issued Staff Position No. 106-2, “Accountingand Disclosure Requirements Related to the Medicare Prescription Drug,Improvement and Modernization Act of 2003” (“FSP 106-2”).   FSP 106-2 permits a sponsor of apostretirement health care plan that provides a prescription drug benefit tomake a one-time election to defer accounting for the effects of the MedicareAct and requires certain disclosures pending determination as to whether thesponsor’s postretirement health care plan reasonably expect to qualify forbeneficial treatment under the Act.  TheCompany qualifies for the subsidy, which approximates $34,000 for the yearended December 31, 2004.  See Footnote15.

 

22

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**ITEM 7A.QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK**

** **

**Market risk represents the risk of changes inthe value of a financial instrument caused by fluctuations in interest rates,foreign currency exchange rates, prices of commodities and equity price risks.**

** **

**CommodityPrice Risk**

** **

**All purchases of electricity are pursuant tolong-term wholesale electric power contracts based on a fixed price for kWhusage, transportation and auxiliary services, with a variable charge for fuelcost, which is generally natural gas. This variable cost is affected byunpredictable factors, including weather and worldwide events, which in turnimpact supply and demand.  The Company’sexposure to purchased power price risk is substantially mitigated because allactual costs of power are able to be recovered from billings to customers.**

** **

**Credit Risk**

** **

**The Company’s concentrations of credit riskconsist primarily of cash, trade accounts receivable, sales concentrations withcertain customers, and notes receivable from third parties.**

** **

**Credit risk with financial institutions isconsidered minimal because of the number and various physical locations ofdifferent financial institutions utilized. In the past, the Company has utilized repurchase agreements, and mayconsider using that vehicle again in the future to maximize return and minimizecredit risk.**

** **

**The Company conducts credit evaluations of newcustomers and assesses the need for a deposit by that customer.  The deposit amount is normally set as 1/6 ofan annual customer billing, with such amounts being refunded or credited to thecustomer after one year if the customer has paid timely at least 10 of theprevious 12 billings.  No customeraccounted for 10% or more of the operating revenues of the Company.**

** **

**The Company sold its limited partner interestsin real estate partnerships in February 2004, in exchange for a note receivableof $286,000 due 2009.  There was no gainor loss on the sale. The note is collateralized by the partnership interests.   The sale of the partnership interestsinvolved the transfer to the buyer of guarantees of debt.**

** **

**The Company sold its investment in UnitedFuel and Energy Corporation in exchange for a note receivable of $1,300,000,which is collateralized by the original stock. The terms of the agreement provide for repayment after United Fuel hascompleted certain capitalization arrangements. All conditions required pursuant to the agreement have been satisfied,and the Company expects payment as scheduled in 2005.**

** **

**InterestRate Risk**

** **

**The Company is subject to market riskassociated with interest rates on our CFC long-term indebtedness.  The Company’s mortgage debt with CFC allowsfor a change from variable rate to fixed rate with no additional fees.  Mortgage notes of $6,467,000 with currentinterest rates of 4.85% are due to be repriced in January 2006, mortgage notesof $64,055,000 with current interest rates of 5.15% are due to be repriced inJanuary 2007,  $33,017,000 with currentinterest rates of 4.7% are due to be repriced in January 2006, $5,960,000 withcurrent interest rates of 4.5% are due to be repriced in January 2007.  No repricing is scheduled for thefollowing:  $27,872,000 with a fixed rateof 4.3%, $3,590,000 with a fixed rate of 4.2%, $2,000 with a fixed rate of 7%,and $2,791,000 are variable rate notes. A 1% change in interest rates would cause a change of $1,438,000 ininterest expense.  The Company attemptsto take advantage of low interest rate environments, as well as repricinginterest rates over staggered periods.**

** **

**Changes in market interest rates affect theinterest earnings on the restricted cash investment which, at December 31,2003, had a balance of $14,169,000.  Theterms of the Beal Bank loan documents provided that the collateral may only beinvested in US government securities, bank certificates of deposit, moneymarket funds or other approved investments, with varying terms of one year orless.  The weighted average interest ratefor the investments for the ten months of 2004 that the investments were heldwas less than one percent.**

 

23

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| **ITEM 8.** | **FINANCIAL  STATEMENTS AND SUPPLEMENTARY DATA** |
|-------------|--------------------------------------------------|

** **

**The Consolidated Financial Statements are setforth on pages F-1 through F-36 of  thisForm 10-K.**

** **
| **ITEM 9.** | **CHANGES IN  AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE** |
|-------------|-------------------------------------------------------------------------------------------|

** **

**None**

** **
| **ITEM 9(a).** | **CONTROLS  AND PROCEDURES** |
|----------------|------------------------------|

** **

Asof the end of the period covered by this report, an evaluation was performedunder the supervision and with the participation of the Company’s management,including the Chief Executive Officer and the Chief Financial Officer, of theeffectiveness of the design and operation of the Company’s disclosure controlsand procedures pursuant to Exchange Act Rule 13a-15.  Based on that evaluation, the Chief ExecutiveOfficer and the Chief Financial Officer concluded that the design and operationof these disclosure controls and procedures were effective.  There have been no changes in the Company’sinternal controls over financial reporting identified in connection with theevaluation referred to above that materially affected, or are reasonably likelyto materially affect, the Company’s internal controls over financial report.

 
| **ITEM 9(b).** | **OTHER  INFORMATION** |
|----------------|------------------------|

** **

None

 

24

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** **

**PARTIII**

** **

**ITEM10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT**

** **

**DirectorsAnd Executive Officers**

** **

**The informationrelating to the Company’s directors required by Item 10 is set forth in thedefinitive proxy statement to be filed with the SEC for the 2005 Annual Meetingof Shareholders to be held on June 14, 2005.  Such information is incorporated herein byreference to the material appearing under the captions “Election of Directors”and “Section 16(a) Beneficial Ownership Reporting Compliance” in the proxystatement to be filed by us with the SEC.**

** **

**The informationrequired by this item concerning the Company’s executive officers is includedin Part I, Item 4, of this Form 10-K.**

** **

**ITEM11. EXECUTIVE COMPENSATION**

 

**The information required by Item 11 will be setforth in the definitive proxy statement to be filed with the SEC for the 2005Annual Meeting of Shareholders to be held on June 14, 2005.  Such information is incorporated herein byreference to the material appearing under the captions “Compensation ofDirectors,”  “Compensation of NamedExecutive Officers,”  “Performance Graph”and “Compensation Committee Report” in the proxy statement to be filed by uswith the SEC.**

** **

**ITEM12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT**

** **

**The informationrequired by Item 12 will be set forth in the definitive proxy statement to befiled with the SEC for the 2005 Annual Meeting of Shareholders to be held on June 14,2005.  Such information is incorporatedherein by reference to the material appearing under the caption “BeneficialOwnership of Voting Securities” and “Equity Compensation Plans” in the proxystatement to be filed by us with the SEC.**

** **

**ITEM13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS**

** **

**The informationrequired by Item 13 will be set forth in the definitive proxy statement to befiled with the SEC for the 2005 Annual Meeting of Shareholders to be held on June 14,2005.  Such information is incorporatedherein by reference to the material appearing under the caption “CertainRelationships and Related Transactions” in the proxy statement to be filed byus with the SEC.**

** **

**ITEM14.  PRINCIPAL ACCOUNTANT FEES ANDSERVICES**

** **

**Information called forby Part III, Item 14, is included in the proxy statement relating to our annualmeeting of shareholders to be held on June 14, 2005, and is incorporatedherein by reference.**

** **

**25**

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** **

**PART IV**

** **

**ITEM15. EXHIBITS, FINANCIAL STATEMENT SCHEDULES AND REPORTS ON FORM 8K**

** **

**FinancialStatements**

** **

**For a list of theconsolidated financial statements filed as part of this Form 10-K, see theIndex to Consolidated Financial Statements on page F-1.**

** **

**FinancialStatement Schedule**

** **

**The following financialstatement schedule is included in Item 14: Schedule II - Valuation andQualifying Accounts for the years ended December 31, 2004, 2003 and 2002.**

** **

**26**

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** **

**Exhibits**

** **
| **Exhibit No.**   | ** ** | **Item**                                                                                                                                                                                                                                                    |
|-------------------|------------|-------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
| **Exhibit 3.1**   | ** ** | **Articles of  Incorporation of the Company and amendments thereto (originally filed with  Amendment No. 1 to Form S-1 dated 3/20/01)(1)**                                                                                                                  |
| **Exhibit 3.2**   | ** ** | **Bylaws of the Company  (originally filed with Amendment No. 1 to Form S-1 dated 3/20/01) (1)**                                                                                                                                                            |
| **Exhibit 3.2a**  | ** ** | **Amended and Restated  Bylaws of Cap Rock Energy Corporation (originally filed with Form 10-K for  year ended 12/31/03 dated 4/10/04) (1)**                                                                                                                |
| **Exhibit 3.3**   | ** ** | **Restated and Amended  Articles of Incorporation of the Cooperative (originally filed with Amendment  No. 1 to Form S-1 dated 3/20/01) (1)**                                                                                                               |
| **Exhibit 3.4**   | ** ** | **Bylaws of the  Cooperative (originally filed with Amendment No. 1 to Form S-1 dated  3/20/01)(1)**                                                                                                                                                        |
| **Exhibit 3.5**   | ** ** | **Amended and Restated  Bylaws of the Company (originally filed with Amendment No. 4 to Form S-1  dated 6/17/01) (1)**                                                                                                                                      |
| **Exhibit 3.6**   | ** ** | **Amended and Restated  Articles of Incorporation of the Company (originally filed with Amendment No.  4 to Form S-1 dated 6/17/01) (1)**                                                                                                                   |
| **Exhibit 3.7**   | ** ** | **Articles of Amendment  to the Amended and Restated Articles of Incorporation of the Company  (originally filed with Amendment No. 4 to Form S-1 dated 6/17/01) (1)**                                                                                      |
| **Exhibit 3.8**   | ** ** | **Amended and Restated  Bylaws of the Company(1)**                                                                                                                                                                                                          |
| **Exhibit 5.1**   | ** ** | **Opinion of Ronald W.  Lyon (original filed with Amendment No. 3 to Form S-1 dated 5/11/01)(1)**                                                                                                                                                           |
| **Exhibit 8.1**   | ** ** | **Tax Opinion of Looper  Reed & McGraw, a Professional Corporation (originally filed with  Amendment No. 2 to Form S-1 dated 4/25/01) (1)**                                                                                                             |
| **Exhibit 10.1**  | ** ** | **Second Amendment to  Transaction Documents dated November 9, 1994, between Southwestern  Public Service Company, the Cooperative, et. al. (originally filed with  Amendment No. 1 to Form S-1 dated 3/20/01) (1)**                                   |
| **Exhibit 10.2**  | ** ** | **Restated Mortgage and  Security Agreement dated September 21, 1988, made by and between the  Cooperative and National Rural Utilities Cooperative Finance Corporation  (originally filed with Amendment No. 1 to Form S-1 dated 3/20/01) (1)**       |
| **Exhibit 10.3**  | ** ** | **Second Restated  Mortgage and Security Agreement dated October 24, 1995, made by and  between the Cooperative and National Rural Utilities Cooperative Finance  Corporation (originally filed with Amendment No. 1 to Form S-1 dated 3/20/01)  (1)** |
| **Exhibit 10.4**  | ** ** | **Loan Agreement dated  October, 1995, between the Cooperative and National Rural Utilities  Cooperative Finance Corporation (originally filed with Form S-1 date July 31,  2001) (1)**                                                                |
| **Exhibit 10.5**  | ** ** | **First Amendment to  Loan Agreement dated as of October 28, 1997, between the Cooperative and  National Rural Utilities Cooperative Finance Corporation (originally filed  with Form S-1 date July 31, 2001) (1)**                               |
| **Exhibit 10.6**  | ** ** | **Loan Agreement dated  as of June 22, 2000, between the Cooperative and National Rural  Utilities Cooperative Finance Corporation and amendment. (originally filed  with Amendment No. 1 to Form S-1 dated 3/20/01)(1)**                              |
| **Exhibit 10.7**  | ** ** | **Loan Agreement dated December 13,  1994, between the Cooperative and National Rural Utilities Cooperative Finance  Corporation (originally filed with Form S-1 date July 31, 2001) (1)**                                                        |
| **Exhibit 10.8**  | ** ** | **Loan Agreement dated March 30,  1993 between the Cooperative and National Rural Utilities Cooperative Finance  Corporation (originally filed with Form S-1 date July 31, 2001) (1)**                                                            |
| **Exhibit 10.9**  | ** ** | **Loan Agreement dated March 10,  1992, TX 107-A-9025, between the Cooperative and National Rural Utilities  Cooperative Finance Corporation (originally filed with Amendment No. 1 to  Form S-1 dated 3/20/01) (1)**                                  |
| **Exhibit 10.10** | ** ** | **Loan Agreement dated  May 17, 1990, between the Cooperative and National Rural Utilities  Cooperative Finance Corporation (originally filed with Amendment No. 1 to  Form S-1 dated 3/20/01)(1)**                                                         |
| **Exhibit 10.11** | ** ** | **Loan Agreement dated March 22,  1990 between the Cooperative and National Rural Utilities Cooperative Finance  Corporation (originally filed with Amendment No. 1 to Form S-1 dated  3/20/01)(1)**                                                   |
| **Exhibit 10.12** | ** ** | **Notice of Meeting and  Proxy Statement for Special Meeting held October 20, 1998 (originally  filed with Amendment No. 1 to Form S-1 dated 3/20/01) (1)**                                                                                            |

 

27

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| **Exhibit 10.13**  | ** ** | **Commitment letter  dated as of February 11, 2000 between National Cooperative Services  Corporation and Cap Rock Energy Corporation for credit facilities associated  with the purchase of certain electric assets owned by Citizens Utilities  Company (originally filed with Form S-1 date July 31, 2001) (1)** |
|--------------------|------------|-------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
| **Exhibit 10.14**  | ** ** | **Loan Agreement dated March 10,  1992, TX 107-A-9026, between the Cooperative and National Rural Utilities  Cooperative Finance Corporation (originally filed with Amendment No. 2 to  Form S-1 dated 4/25/01) (1)**                                                                                                    |
| **Exhibit 10.15**  | ** ** | **Purchase and Sale  Agreement dated as of February 11, 2000 between the Company, the  Cooperative and Citizens Utilities Company regarding Arizona Electric  (originally filed with Amendment No. 1 to Form S-1 dated 3/20/01)(1)**                                                                                     |
| **Exhibit 10.16**  | ** ** | **Purchase and Sale  Agreement dated as of February 11, 2000 between the Company, the  Cooperative and Citizens Utilities Company regarding Vermont Electric.  (originally filed with Amendment No. 1 to Form S-1 dated 3/20/01)(1)**                                                                                    |
| **Exhibit 10.17**  | ** ** | **Power Sale Agreement  dated May 1, 1999, between the Cooperative and Electric Clearinghouse, Inc.  (originally filed with Amendment No. 1 to Form S-1 dated 3/20/01)(1)**                                                                                                                                                   |
| **Exhibit 10.18**  | ** ** | **Wholesale Power  Supply and Services Contract dated April 16, 1997 Between Texas New  Mexico Power Company and the Cooperative (originally filed with Amendment No.  1 to Form S-1 dated 3/20/01)(1)**                                                                                                                 |
| **Exhibit 10.19**  | ** ** | **Southwestern Public  Service Company Wholesale Full Requirements Service Rate Schedule and  related Agreement, as amended, with the Cooperative (originally filed with  Amendment No. 1 to Form S-1 dated 3/20/01)(1)**                                                                                                |
| **Exhibit 10.20**  | ** ** | **Ordinance of the City  of Greenville, Texas Granting to the Cooperative a franchise for the  transmission and distribution of electricity (originally filed with Amendment  No. 1 to Form S-1 dated 3/20/01)(1)**                                                                                                           |
| **Exhibit 10.21**  | ** ** | **Ordinance of the City  of Midland, Texas Granting to the Cooperative a franchise for the  transmission and distribution of electricity (originally filed with Amendment  No. 1 to Form S-1 dated 3/20/01)(1)**                                                                                                              |
| **Exhibit 10.22**  | ** ** | **Ordinance of the City  of Stanton, Texas Granting to the Cooperative a franchise for the  transmission and distribution of electricity (originally filed with Form S-1  date July 31, 2001) (1)**                                                                                                                      |
| **Exhibit 10.23**  | ** ** | **Employment Contract  between the Cooperative and Ulen North dated July 21, 1992 (originally  filed with Amendment No. 1 to Form S-1 dated 3/20/01) (originally filed with  Form 10-K for year ended 12/31/03 dated 4/10/03) (1)**                                                                                      |
| **Exhibit 10.23a** | ** ** | **Employment Contract  between Cap Rock Energy Corporation and Ulen A. North, Jr. dated September 12,  2001 (originally filed with Amendment No. 2 to Form S-1 dated 4/25/01) (1)**                                                                                                                                      |
| **Exhibit 10.24**  | ** ** | **Employment Contract  between the Cooperative and David W. Pruitt dated August 3, 1992  (originally filed with Amendment No. 2 to Form S-1 dated 4/25/01) (1)**                                                                                                                                                         |
| **Exhibit 10.24a** | ** ** | **Employment Contract  between Cap Rock Energy Corporation and David W. Pruitt dated September 11,  2001**(originally  filed with Form 10-K for year ended 12/31/03 dated 4/10/04) (1)                                                                                                                                   |
| **Exhibit 10.25**  | ** ** | **Achievement Based  Compensation Agreement Corporate Asset Non-CFC Financing Arrangements dated August 28,  1994 (originally filed with Form S-1 date July 31, 2001) (1)**                                                                                                                                         |
| **Exhibit 10.26**  | ** ** | **Achievement Based  Compensation Agreement Corporate Asset Non-CFC Financing Arrangements dated October 27,  1992 (originally filed with Form S-1 date July 31, 2001) (1)**                                                                                                                                        |
| **Exhibit 10.27**  | ** ** | **The Cooperatives  Supplemental Executive Deferred Compensation Retirement Plan (originally  filed with Amendment No. 1 to Form S-1 dated 3/20/01)(1)**                                                                                                                                                                      |
| **Exhibit 10.28**  | ** ** | **Cap Rock Energy  Corporation 2001 Stock Incentive Plan (originally filed with Amendment No. 1  to Form S-1 dated 3/20/01)(1)**                                                                                                                                                                                              |
| **Exhibit 10.29**  | ** ** | **Cap Rock Energy  Corporation 2001 Employee Stock Purchase Plan (originally filed with  Amendment No. 1 to Form S-1 dated 3/20/01)(1)**                                                                                                                                                                                      |
| **Exhibit 10.30**  | ** ** | **Form of Equity &  Membership Redemption Options (originally filed with Amendment No. 1 to Form  S-1 dated 3/20/01)(1)**                                                                                                                                                                                                 |
| **Exhibit 10.31**  | ** ** | **Form of Equity  Redemption Options (originally filed with Amendment No. 1 to Form S-1 dated  3/20/01)(1)**                                                                                                                                                                                                                  |
| **Exhibit 10.32**  | ** ** | **Agreement for  Purchase and Sale dated February 7, 2000, by and among Walter Mickelson,  et al., Multimedia Development Corporation and New West Resources, Inc.  (originally filed with Amendment No. 1 to Form S-1 dated 3/20/01)(1)**                                                                               |
| **Exhibit 10.33**  | ** ** | **Stock Acquisition  Agreement dated January 1, 2001, between Thomas E. Kelly, Richard C.**                                                                                                                                                                                                                              |

 

28

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| ** **        | ** ** | **Skillern, Johnny D.  Grimes, Billy D. Grimes and New West Resources, Inc. (originally filed with  Amendment No. 2 to Form S-1 dated 4/25/01) (1)**                                                                                        |
|-------------------|------------|---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
| **Exhibit 10.34** | ** ** | **Consolidating Loan  Agreement dated March 30, 1993 between Cap Rock Electric Cooperative,  Inc. and National Rural Utilities Cooperative Finance Corporation (originally  filed with Amendment No. 1 to Form S-1 dated 3/20/01)(1)** |
| **Exhibit 10.35** | ** ** | **Integrated Supply  Agreement between Cap Rock Electric Cooperative, Inc. and Temple, Inc. (originally  filed with Amendment No. 2 to Form S-1 dated 4/25/01) (1)**                                                                        |
| **Exhibit 10.36** | ** ** | **Employment Contract  between the Cooperative and Mickey Sims (originally filed with Amendment No.  1 to Form S-1 dated 3/20/01)(1)**                                                                                                      |
| **Exhibit 10.37** | ** ** | **Amendment to Line of  Credit Agreement dated June 27, 1997 between National Rural Utilities  Cooperative Finance Corporation and the Cooperative (originally filed with  Amendment No. 1 to Form S-1 dated 3/20/01)(1)**             |
| **Exhibit 10.38** | ** ** | **Loan Agreement dated March 10,  1992, TX 107-A-9027, between the Cooperative and National Rural Utilities  Cooperative Finance Corporation (originally filed with Amendment No. 2 to  Form S-1 dated 4/25/01) (1)**                  |
| **Exhibit 10.39** | ** ** | **Achievement Based  Compensation Contract, Merger or Acquisition with Other Electric Utilities  dated August 22, 2000 (originally filed with Amendment No. 1 to Form S-1  dated 3/20/01)(1)**                                         |
| **Exhibit 10.40** | ** ** | **Loan Agreement dated March 10,  1992, TX 107-A-9024, between Cooperative and National Rural Utilities  Cooperative Finance Corporation (originally filed with Amendment No. 2 to  Form S-1 dated 4/25/01) (1)**                      |
| **Exhibit 10.41** | ** ** | **Wholesale Power  Agreement dated June 25, 1977, between Lower Colorado River Authority  and McCulloch Electric Cooperative, Inc. (originally filed with Amendment No.  1 to Form S-1 dated 3/20/01)(1)**                             |
| **Exhibit 10.42** | ** ** | **Amendment to  Wholesale Power Agreement dated September 28, 1987 between Lower  Colorado River Authority and McCulloch Electric Cooperative, Inc. (originally  filed with Amendment No. 1 to Form S-1 dated 3/20/01)(1)**            |
| **Exhibit 10.43** | ** ** | **Director Compensation  Plan of the Company (originally filed with Amendment No. 1 to Form S-1 dated  3/20/01)(1)**                                                                                                                        |
| **Exhibit 10.44** | ** ** | **Trust Agreement for  the Cooperative Supplemental Executive Deferred Compensation Retirement Plan  (originally filed with Amendment No. 1 to Form S-1 dated 3/20/01)(1)**                                                                 |
| **Exhibit 10.45** | ** ** | **CFC Secured Revolving  Line of Credit Agreement dated June 24, 1997 (originally filed with  Amendment No. 1 to Form S-1 dated 3/20/01)(1)**                                                                                          |
| **Exhibit 10.46** | ** ** | **Achievement Based  Compensation Contract, Merger or Acquisition with Other Electric Utilities  dated June 29, 1999 (originally filed with Amendment No. 1 to Form S-1  dated 3/20/01)(1)**                                           |
| **Exhibit 10.47** | ** ** | **Agreement to Combine  McCulloch and Cap Rock Electric Cooperatives dated June 30, 1999  (originally filed with Amendment No. 1 to Form S-1 dated 3/20/01)(1)**                                                                       |
| **Exhibit 10.48** | ** ** | **Management Service  Agreement between Cooperative and Lamar Electric Cooperative Association  (originally filed with Amendment No. 1 to Form S-1 dated 3/20/01)(1)**                                                                      |
| **Exhibit 10.49** | ** ** | **Notice of Annual  Meeting and Proxy Statement for Members of McCulloch Electric Cooperative  held on August 21, 1999 (originally filed with Amendment No. 1 to Form  S-1 dated 3/20/01)(1)**                                         |
| **Exhibit 10.50** | ** ** | **Agreement to Combine  Lamar and Cap Rock Electric Cooperatives dated October 28, 1999  (originally filed with Amendment No. 1 to Form S-1 dated 3/20/01)(1)**                                                                        |
| **Exhibit 10.51** | ** ** | **Loan Agreement  between New West Resources, Inc, Cap Rock Electric Cooperative, Inc. and Bank  United Texas FSB dated July 12, 2000 (originally filed with Amendment  No. 1 to Form S-1 dated 3/20/01)(1)**                          |
| **Exhibit 10.52** | ** ** | **Unconditional  Guaranty from Cap Rock Electric Cooperative to Bank United Texas FSB dated July 12,  2000 (originally filed with Amendment No. 1 to Form S-1 dated 3/20/01) (1)**                                                     |
| **Exhibit 10.53** | ** ** | **Lamar County Electric  Cooperative Association Notice of Special Meeting and Proxy Statement for  Special Meeting held December 14, 1999 (originally filed with Amendment  No. 1 to Form S-1 dated 3/20/01)(1)**                     |
| **Exhibit 10.54** | ** ** | **Signature Leasing,  Inc. Master Lease Agreement dated April 1, 2000 (originally filed with  Amendment No. 1 to Form S-1 dated 3/20/01)(1)**                                                                                          |
| **Exhibit 10.55** | ** ** | **Personal Services  Agreement between Leonard S. Herring and the Cooperative dated December 16,  1999 (originally filed with Amendment No. 1 to Form S-1 dated 3/20/01)(1)**                                                          |
| **Exhibit 10.56** | ** ** | **Term Loan Agreement  between Eddins-Walcher Company, Frank’s Fuels, United Fuel & Energy**                                                                                                                                       |

 

29

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| ** **         | ** ** | **Corporation, and New  West Resources dated July 12, 2000 (originally filed with Amendment No.  1 to Form S-1 dated 3/20/01)(1)**                                                                                                  |
|--------------------|------------|------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
| **Exhibit 10.57**  | ** ** | **NewCorp Resources  Electric Cooperative Open Access Transmission Tariff (originally filed with  Amendment No. 1 to Form S-1 dated 3/20/01)(1)**                                                                                        |
| **Exhibit 10.58**  | ** ** | **Supplement to the  Restated Mortgage and Security Agreement between the Cooperative and CFC  dated May 17, 1990 (originally filed with Amendment No. 1 to Form S-1 dated  3/20/01)(1)**                                                |
| **Exhibit 10.59**  | ** ** | **Loan Agreement  between Cap Rock Cooperative Finance Corporation and CFC dated June 22,  1999 (originally filed with Amendment No. 1 to Form S-1 dated 3/20/01)(1)**                                                              |
| **Exhibit 10.60**  | ** ** | **Confirmation Letter  between Electric Clearinghouse, Inc. and the Cooperative dated May 27, 1999  (originally filed with Amendment No. 1 to Form S-1 dated 3/20/01)(1)**                                                               |
| **Exhibit 10.61**  | ** ** | **Service Agreement  Rate Schedule WP between NewCorp Resources and Cap Rock Electric  Cooperative dated March 31, 1995 (originally filed with Amendment No. 1  to Form S-1 dated 3/20/01)(1)**                                |
| **Exhibit 10.62**  | ** ** | **Transaction Agreement  dated as of September 9, 1993 between Southwestern Public Service  Company, the Cooperative and OTP, Inc. (originally filed with Amendment No. 1  to Form S-1 dated 3/20/01)(1)**                          |
| **Exhibit 10.63**  | ** ** | **Assignment of  Certificate of Convenience and Necessity by the Cooperative to NewCorp  Resources dated January 17, 1996 (originally filed with Amendment No. 1  to Form S-1 dated 3/20/01)(1)**                                   |
| **Exhibit 10.64**  | ** ** | **Supplemental  Agreement between NewCorp Resources and the Cooperative dated April 25,  1995 (originally filed with Amendment No. 1 to Form S-1 dated 3/20/01)(1)**                                                                |
| **Exhibit 10.65**  | ** ** | **Third Amendment to  Transaction Documents by and among Southwestern Public Service Company, the  Cooperative, NewCorp Resources et al dated March 3, 1995 (originally  filed with Amendment No. 1 to Form S-1 dated 3/20/01)(1)** |
| **Exhibit 10.66**  | ** ** | **Assignment of  Wholesale Power Contract from the Cooperative to NewCorp Resources dated March 3,  1995 (originally filed with Amendment No. 1 to Form S-1 dated 3/20/01)(1)**                                                     |
| **Exhibit 10.67**  | ** ** | **QSE and Ancillary  Services Agreement between the Cooperative and Garland Power and Light dated June 1,  2001 (originally filed with Amendment No. 2 to Form S-1 dated 4/25/01) (1)**                                             |
| **Exhibit 10.68**  | ** ** | **Letter of Intent  between the Company and Boeing Capital Corporation dated June 5, 2001(1)**                                                                                                                                      |
| **Exhibit 10.69**  | ** ** | **Employment Contract  between the Company and Lee D. Atkins dated September 1, 2001  (originally filed with Post Effective Amendment No. to Form S-1 dated  12/31/01) (1)**                                                        |
| **Exhibit 10.70**  | ** ** | **Employment Contract  between the Company and Ronald W. Lyon(originally filed with Post Effective  Amendment No. 1 to Form S-1 dated 12/31/01) (1)**                                                                                    |
| **Exhibit 10.70a** | ** ** | **Employment Contract  between Cap Rock Energy Corporation and Ronald Lyon dated October 24,  2001 (originally filed with Form 10-K for year ended 12/31/03 dated 4/10/04)  (1)**                                                   |
| **Exhibit 10.71**  | ** ** | **Employment Contract  between the Company and Sam Prough dated September 14, 2001 (originally  filed with Post Effective Amendment No. to Form S-1 dated 12/31/01) (1))**                                                          |
| **Exhibit 10.72**  | ** ** | **Achievement Based  Compensation Agreement Corporate Asset Non-CFC Financing Arrangements dated August 21,  2001 (originally filed with Post Effective Amendment No. 1 to Form S-1 dated  12/31/01) (1)**                          |
| **Exhibit 10.73**  | ** ** | **Letter from State  Securities Board of the State of Texas dated December 6, 2001  (originally filed with Post Effective Amendment No. 1 to Form S-1 dated  12/31/01) (1)**                                                        |
| **Exhibit 10.74**  | ** ** | **Employment Contract  between the Company and Celia A. Zinn dated September 20, 2001  (originally filed with Form 10-K for period ended 12/31/02 dated 4/10/03) (1)**                                                              |
| **Exhibit 10.75**  | ** ** | **Cap Rock Energy  Corporation Shareholders’ Trust (originally filed with Form 10-K for period  ended 12/31/02 dated 4/10/03) (1)**                                                                                                 |
| **Exhibit 10.76**  | ** ** | **Cap Rock Energy  Corporation Trust Share Option Agreement (originally filed with Form 10-K for  period ended 12/31/02 dated 4/10/03) (1)**                                                                                             |
| **Exhibit 10.77**  | ** ** | **Cap Rock Energy  Corporation Trust Funding Agreement (originally filed with Form 10-K for year  ended 12/31/02 dated 4/10/03) (1)**                                                                                                    |
| **Exhibit 10.78**  | ** ** | **Supplemental  Executive Deferred Compensation Retirement Plan dated November 14, 2002  (originally filed with Form 10-K for period ended 12/31/02 dated 4/10/03)(1)**                                                             |
| **Exhibit 10.79**  | ** ** | **Beal Bank Loan  Agreements dated September 8, 2003 (originally filed with Form 10-Q for  the period ended 9/30/03 dated 11/13/03) (1)**                                                                                           |
| **Exhibit 10.80**  | ** ** | **Washington Mutual Modification  and Extension Agreement dated October 9, 2003 (originally**                                                                                                                                       |

 

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| ** **        | ** ** | **filed with Form 10-Q  for the period ended 9/30/03 dated 11/13/03) (1)**                                                                                                                                                                                                 |
|-------------------|------------|----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
| **Exhibit 10.81** | ** ** | **Achievement Based  Compensation Contract, Southwestern Public Service Company Contract dated October 27,  1992 (originally filed with Form 10-K for year ended 12/31/03 dated 4/10/03)  (1)**                                                                       |
| **Exhibit 10.82** | ** ** | **Managed Services  Agreement with Delinea Corporation dated March 12, 2003 (originally  filed with Form 10-K for year ended 12/31/03 dated 4/10/03) (1)**                                                                                                            |
| **Exhibit 10.83** | ** ** | **Master Operation,  Maintenance and Administrative Services Agreement dated September 29,  2003 between Cap Rock Energy Corporation and NewCorp Resources Electric  Cooperative, Inc. (originally filed with Form 10-K for year ended 12/31/03  dated 4/10/04) (1)** |
| **Exhibit 10.84** | ** ** | **Stock Acquisition  Agreement between NewCorp Resources Electric Cooperative, Inc. and United  Fuel and Energy Corporation dated March 18, 2004 (originally filed with  Form 10-K for year ended 12/31/03 dated 4/10/04) (1)**                                       |
| **Exhibit 10.85** | ** ** | **Employment Contract  between Cap Rock Energy Corporation and William West dated December 30,  2003 (originally filed with Form 10-Q for period ended 06/30/04 dated  08/1904) (1)**                                                                                 |
| **Exhibit 10.86** | ** ** | **Amended Letter  between Beal Bank S.S.B. and New Corp Resources dated September 9, 2004  (originally filed with Form 8-K dated 0/28/04) (1)**                                                                                                                       |
| **Exhibit 10.87** | ** ** | **Second Amended Letter  between Beal Bank S.S.B. and New Corp Resources dated September 24, 2004  (originally filed with Form 8-K dated 10/01/04) (1)**                                                                                                              |
| **Exhibit 10.88** | ** ** | **Amended Shareholders’  Trust between Cap Rock Energy Corporation Shareholders’ Trust and Alfred J.  Schwartz and Robert G. Holman dated December 31, 2004 (originally filed  with Form 8-K dated 1/06/05) (1)**                                           |
| **Exhibit 10.89** | ** ** | **Right of First  Refusal Agreement between Cap Rock Energy Corporation Shareholders’ Trust and  Alfred J. Schwartz and Robert G. Holman dated December 31, 2004  (originally filed with Form 8-K dated 1/06/05) (1)**                                           |
| **Exhibit 10.90** | ** ** | **Voting Agreement  between Cap Rock Energy Corporation Shareholders’ Trust and Alfred J.  Schwartz and Robert G. Holman dated December 31, 2004 (originally filed  with Form 8-K dated 1/06/05) (1)**                                                           |
| **Exhibit 10.91** | ** ** | **Proposal For  Decision, PUC Docket No. 28813, issued March 17, 2005 (originally filed  with Form 8-K dated 3/17/05)(1)**                                                                                                                                            |
| **Exhibit 14.1**  | ** ** | **Cap Rock Energy  Corporation Code of Ethics dated December 2, 2003 (originally filed with  Form 10-K for year ended 12/31/03 dated 4/10/04) (1)**                                                                                                                   |
| **Exhibit 18.1**  | ** ** | **Change in Accounting  Principle Letter from KPMG LLP (originally filed with Form 10-Q dated  5/15/03)(1)**                                                                                                                                                               |
| **Exhibit 20.1**  | ** ** | **Election Form  (originally filed with Amendment No. 1 to Form S-1 dated 3/20/01)(1)**                                                                                                                                                                                    |
| **Exhibit 21.1**  | ** ** | **Subsidiaries of the  Company (originally filed with Amendment No. 1 to Form S-1 dated 3/20/01)(1)**                                                                                                                                                                      |
| **Exhibit 23.2**  | ** ** | **Consent of Ronald W.  Lyon is contained in his opinion filed as Exhibit 5.1 to this registration  statement.(1)**                                                                                                                                                        |
| **Exhibit 23.3**  | ** ** | **Consent of Bolinger,  Segars, Gilbert & Moss, L.L.P. (originally filed with Amendment No. 2 to  Form S-1 dated 4/25/01) (1)**                                                                                                                                        |
| **Exhibit 23.4**  | ** ** | **Consent of Looper  Reed & McGraw (originally filed with Amendment No. 2 to Form S-1 dated  4/25/01) (1)**                                                                                                                                                            |
| **Exhibit 31.1**  | ** ** | **Certification  Pursuant to 18 U.S.C. Section 1350, as Adopted Pursuant to Section 302  of the Sarbanes-Oxley Act of 2002 of David W. Pruitt (2)**                                                                                                              |
| **Exhibit 31.2**  | ** ** | **Certification  Pursuant to 18 U.S.C. Section 1350, as Adopted Pursuant to Section 302  of the Sarbanes-Oxley Act of 2002 of Lee D. Atkins (2)**                                                                                                                |
| **Exhibit 32.1**  | ** ** | **Certification  Pursuant to 18 U.S.C. Section 1350, as Adopted Pursuant to Section 906  of the Sarbanes-Oxley Act of 2002 of David W. Pruitt)(2)**                                                                                                              |
| **Exhibit 32.2**  | ** ** | **Certification  Pursuant to 18 U.S.C. Section 1350, as Adopted Pursuant to Section 906  of the Sarbanes-Oxley Act of 2002 of Lee D. Atkins (2)**                                                                                                                |

** **

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**(1)**                                  Previously filed

** **

**(2)**                                  Filed herewith

** **

**31**

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** **

**SIGNATURES**

** **

**In accordance with therequirements of the Securities Act of 1934, as amended, the Registrantcertifies that it has reasonable grounds to believe that it meets all of therequirements for filing Form 10K and authorizes this Form 10K to be signed onits behalf by the undersigned, thereunto duly authorized, in the City ofMidland, Texas, on March 25, 2005.**

** **
| ** **   | **CAP ROCK ENERGY CORPORATION**    |
|--------------|------------------------------------|
| ** **   | ** **                         |
| ** **   | **By:**                            | ** ** |
| ** **   | ** **                         | **/s/ DAVID W. PRUITT** |
| ** **   | **David W. Pruitt**                |
| *** *** | ***Co-Chairman of the Board and*** |
| *** *** | ***Chief Executive Officer***      |

** **

**Pursuant to therequirements of the Securities Exchange Act of 1934 this report has been signedbelow by the following persons on behalf of the registrant and in thecapacities and on the dates indicated.**

** **
| **Signature**                | ** ** | **Title**                                                        | ** ** | **Date**                |
|------------------------------|------------|------------------------------------------------------------------|------------|-------------------------|
| ** **                   | ** ** | ** **                                                       | ** ** | ** **              |
| **/s/ DAVID W. PRUITT**      | ** ** | **Director, Co-Chairman of the Board,  Chief Executive Officer** | ** ** | **March 25, 2005** |
| **David W. Pruitt**          | ** ** | ** **                                                       | ** ** |
| ** **                   | ** ** | ** **                                                       | ** ** | ** **              |
| **/s/ WILLIAM L. WEST**      | ** ** | **Director, President**                                          | ** ** | **March 25, 2005** |
| **William L. West**          | ** ** | ** **                                                       | ** ** | ** **              |
| ** **                   | ** ** | ** **                                                       | ** ** | ** **              |
| **/s/ RUSSELL E. JONES**     | ** ** | **Director, Co-Chairman of the Board**                           | ** ** | **March 25, 2005** |
| **Russell E. Jones**         | ** ** | ** **                                                       | ** ** | ** **              |
| ** **                   | ** ** | ** **                                                       | ** ** | ** **              |
| **/s/ S. D. BUCHANAN**       | ** ** | **Director**                                                     | ** ** | **March 25, 2005** |
| **S. D. Buchanan**           | ** ** | ** **                                                       | ** ** | ** **              |
| ** **                   | ** ** | ** **                                                       | ** ** | ** **              |
| **/s/ FLOYD L. RITCHEY**     | ** ** | **Director**                                                     | ** ** | **March 25, 2005** |
| **Floyd L. Ritchey**         | ** ** | ** **                                                       | ** ** | ** **              |
| ** **                   | ** ** | ** **                                                       | ** ** | ** **              |
| **/s/ MICHAEL D. SCHAFFNER** | ** ** | **Director**                                                     | ** ** | **March 25, 2005** |
| **Michael D. Schaffner**     | ** ** | ** **                                                       | ** ** | ** **              |

** **

**32**

----

** **

**CAP ROCK ENERGY CORPORATIONSCHEDULE II — VALUATION AND QUALIFYING ACCOUNTSALLOWANCE FOR DOUBTFUL ACCOUNTS(AMOUNTS STATED IN THOUSANDS)**

 
| **COLUMN A -  DESCRIPTION** | ** ** | **COLUMN B -  BALANCE AT  BEGINNING OF  PERIOD** | ** ** | **COLUMN C -  CHARGED TO  COSTS AND  EXPENSES** | ** ** | **COLUMN D -  DEDUCTION-  CHARGED-  OFF** | ** ** | **COLUMN E-  BALANCE AT  END OF  PERIOD** | ** ** |
|-----------------------------|------------|--------------------------------------------------|------------|-------------------------------------------------|------------|-------------------------------------------|------------|-------------------------------------------|------------|
| ** **                  | ** ** | ** **                                       | ** ** | ** **                                      |
| ** **                  | ** ** | ** **                                       | ** ** | ** **                                      |
| ** **                  | ** ** | ** **                                       | ** ** | ** **                                      |
| December 31,  2004     |       | $                                                | 78         |                                            | $          | 151                                       |       | $                                         | 114        |   | $ | 115 |   |
| December 31,  2003     |       | $                                                | 50         |                                            | $          | 113                                       |       | $                                         | 85         |   | $ | 78 |   |
| December 31,  2002     |       | $                                                | 202        |                                            | $          | 113                                       |       | $                                         | 265        |   | $ | 50 |   |

 

33

----

 

**INDEX TO FINANCIAL STATEMENTS**

** **
| **Report  of Independent Registered Public Accounting Firm, KPMG LLP** | ** ** | ** ** |
|------------------------------------------------------------------------|------------|------------|
| ** **                                                             | ** ** | ** ** |
| **Consolidated  Statements of Operations**                             | ** ** | ** ** |
| **Years ended December 31,  2004, 2003 and 2002**                 | ** ** | ** ** |
| ** **                                                             | ** ** | ** ** |
| **Consolidated Balance Sheets**                                        | ** ** | ** ** |
| **December 31, 2004 and  2003**                                   | ** ** | ** ** |
| ** **                                                             | ** ** | ** ** |
| **Consolidated  Statements of Equity**                                 | ** ** | ** ** |
| **Years ended December 31,  2004, 2003 and 2002**                 | ** ** | ** ** |
| ** **                                                             | ** ** | ** ** |
| **Consolidated  Statements of Cash Flows**                             | ** ** | ** ** |
| **Years ended December 31,  2004, 2003 and 2002**                 | ** ** | ** ** |
| ** **                                                             | ** ** | ** ** |
| **Notes to  Consolidated Financial Statements**                        | ** ** | ** ** |

** **

**F-1**

----

** **

**REPORT OF INDEPENDENT REGISTERED PUBLICACCOUNTING FIRM**

** **

**The Board of Directors and StockholdersCap Rock Energy Corporation:**

 

**We have audited the accompanying consolidated balance sheets of CapRock Energy Corporation and subsidiaries (the Company) as of December 31,2004 and 2003, and the related consolidated statements of operations, statementof equity, and cash flows for each of the years in the three-year period ended December 31,2004.  In connection with our audits ofthe consolidated financial statements, we also have audited financial statementschedule II.   These consolidatedfinancial statements and financial statement schedule are theresponsibility of the Company’s management. Our responsibility is to express an opinion on these consolidatedfinancial statements and financial statement schedule based on our audits.**

 

**We conducted our audits in accordance with the standards of the PublicCompany Accounting Oversight Board (United States).  Those standards require that we plan andperform the audit to obtain reasonable assurance about whether the financialstatements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting theamounts and disclosures in the financial statements.  An audit also includes assessing theaccounting principles used and significant estimates made by management, as wellas evaluating the overall financial statement presentation.  We believe that our audits provide areasonable basis for our opinion.**

 

**In our opinion, the consolidated financial statements referred to abovepresent fairly, in all material respects, the financial position of Cap RockEnergy Corporation and subsidiaries as of December 31, 2004 and 2003, andthe results of their operations and their cash flows for each of the years inthe three-year period ended December 31, 2004, in conformity with U. S.generally accepted account principles. Also in our opinion, the related financial statement schedule, whenconsidered in relation to the basic financial statements taken as a whole,presents fairly, in all material respects, the information set forth therein.**

 

 

**KPMG LLP**

** **

**Midland, TexasMarch 25, 2005**

** **

**F-2**

----

 

**CAP ROCK ENERGY CORPORATIONCONSOLIDATED STATEMENTS OFOPERATIONS**

** **
| ** **                                          | ** ** | **YEAR ENDED DECEMBER 31,**                                | ** ** |
|-----------------------------------------------------|------------|-----------------------------------------------------------------|------------|
| ** **                                          | ** ** | **2004**                                                        | ** ** | **2003** | ** ** | **2002** | ** ** |
| ** **                                          | ** ** | **(Thousands of dollars except shares  and per share amounts)** | ** ** |
| **Operating Revenues:**                             |       |                                                            |       |   |   |   |   |
| Electric revenues                                   |       | $                                                               | 81,149     |   | $ | 81,402 |   | $ | 73,335 |   |
| Other                                               |       | 1,475                                                           |       | 1,442 |   | 1,302 |   |
| Total operating revenues                            |       | 82,624                                                          |       | 82,844 |   | 74,637 |   |
|                                                |       |                                                            |       |   |   |   |   |
| **Operating Expenses:**                             |       |                                                            |       |   |   |   |   |
| Purchased power                                     |       | 40,032                                                          |       | 36,578 |   | 36,433 |   |
| Operations and maintenance                          |       | 10,331                                                          |       | 10,135 |   | 7,327 |   |
| General and administrative                          |       | 7,518                                                           |       | 4,639 |   | 7,144 |   |
| Stock compensation                                  |       | 4,925                                                           |       | 2,133 |   | — |   |
| Depreciation and amortization                       |       | 7,416                                                           |       | 6,719 |   | 5,834 |   |
| Property taxes                                      |       | 1,925                                                           |       | 1,345 |   | 1,367 |   |
| Other                                               |       | 258                                                             |       | 326 |   | 202 |   |
| Total operating expenses                            |       | 72,405                                                          |       | 61,875 |   | 58,307 |   |
|                                                |       |                                                            |       |   |   |   |   |
| **Operating Income**                                |       | 10,219                                                          |       | 20,969 |   | 16,330 |   |
|                                                |       |                                                            |       |   |   |   |   |
| **Other Income (Expense):**                         |       |                                                            |       |   |   |   |   |
| Allocation of income from associated  organizations |       | 540                                                             |       | 530 |   | 478 |   |
| Interest expense, net of capitalized  interest      |       | (7,983                                                          | )          | (8,047 | ) | (7,403 | ) |
| Interest and other income                           |       | 646                                                             |       | 795 |   | 1,027 |   |
| Impairment of Lamar combination costs (Note  4)     |       | —                                                          |       | — |   | (1,357 | ) |
| Loss on sale of MAP stock                           |       | —                                                          |       | (1,056 | ) | — |   |
| Equity earnings in MAP (Notes 7)                    |       | —                                                          |       | 144 |   | 115 |   |
| Stockholders’ Trust                            |       | (129                                                            | )          | — |   | — |   |
| Total other income (expense)                        |       | (6,926                                                          | )          | (7,634 | ) | (7,140 | ) |
|                                                |       |                                                            |       |   |   |   |   |
| **Income before income taxes**                      |       | 3,293                                                           |       | 13,335 |   | 9,190 |   |
| Income tax expense (benefit)                        |       | (2,140                                                          | )          | 2,137 |   | 414 |   |
|                                                |       |                                                            |       |   |   |   |   |
| **Net Income**                                      |       | $                                                               | 5,433      |   | $ | 11,198 |   | $ | 8,776 |   |
|                                                |       |                                                            |       |   |   |   |   |
| **Net income per common share:**                    |       |                                                            |       |   |   |   |   |
| Basic                                               |       | $                                                               | 3.51       |   | $ | 7.69 |   | $ | 6.74 |   |
| Diluted                                             |       | $                                                               | 3.40       |   | $ | 7.41 |   | $ | 6.74 |   |
|                                                |       |                                                            |       |   |   |   |   |
| **Weighted average number of shares  outstanding:** |       |                                                            |       |   |   |   |   |
| Basic                                               |       | 1,546,271                                                       |       | 1,455,443 |   | 1,302,355 |   |
| Diluted                                             |       | 1,596,796                                                       |       | 1,510,741 |   | 1,302,355 |   |

** **

Theaccompanying notes are an integral part of these consolidated financialstatements.

 

**F-3**

----

** **

**CAP ROCK ENERGY CORPORATIONCONSOLIDATED BALANCE SHEETS**
| ** **                                                                                                                                                                                                                           | ** ** | **DECEMBER 31,**      | ** ** |
|--------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|------------|----------------------------|------------|
| ** **                                                                                                                                                                                                                           | ** ** | **2004**                   | ** ** | **2003** | ** ** |
| ** **                                                                                                                                                                                                                           | ** ** | **(Thousands of dollars)** | ** ** |
| **ASSETS**                                                                                                                                                                                                                           |       |                       |       |   |   |
| ** **                                                                                                                                                                                                                           |       |                       |       |   |   |
| **Current Assets:**                                                                                                                                                                                                                  |       |                       |       |   |   |
| Cash                                                                                                                                                                                                                                 |       | $                          | 20,968     |   | $ | 12,170 |   |
| Restricted cash investment                                                                                                                                                                                                           |       | —                     |       | 14,169 |   |
| Accounts receivable:                                                                                                                                                                                                                 |       |                       |       |   |   |
| Electric sales, net                                                                                                                                                                                                                  |       | 7,313                      |       | 8,500 |   |
| Other                                                                                                                                                                                                                                |       | 457                        |       | 371 |   |
| Current notes receivable (Notes 7 and 13)                                                                                                                                                                                            |       | —                     |       | 1,250 |   |
| Other current assets (Note 6)                                                                                                                                                                                                        |       | 5,431                      |       | 1,587 |   |
| **Total current assets**                                                                                                                                                                                                             |       | 34,169                     |       | 38,047 |   |
|                                                                                                                                                                                                                                 |       |                       |       |   |   |
| **Utility plant, net (Note 8)**                                                                                                                                                                                                      |       | 149,361                    |       | 152,162 |   |
| **Investments and notes receivable (Note 7)**                                                                                                                                                                                        |       | 11,004                     |       | 10,045 |   |
| **Nonutility property, net (Note 9)**                                                                                                                                                                                                |       | 1,227                      |       | 1,545 |   |
| **Regulatory and other assets (Note 10)**                                                                                                                                                                                            |       | 3,926                      |       | 1,190 |   |
| **Total Assets**                                                                                                                                                                                                                     |       | $                          | 199,687    |   | $ | 202,989 |   |
|                                                                                                                                                                                                                                 |       |                       |       |   |   |
| **LIABILITIES AND EQUITY**                                                                                                                                                                                                           |       |                       |       |   |   |
|                                                                                                                                                                                                                                 |       |                       |       |   |   |
| **Current Liabilities:**                                                                                                                                                                                                             |       |                       |       |   |   |
| Current portion of long-term debt                                                                                                                                                                                                    |       | $                          | 10,005     |   | $ | 4,654 |   |
| Short-term note payable                                                                                                                                                                                                              |       | —                     |       | 14,169 |   |
| Accounts payable:                                                                                                                                                                                                                    |       |                       |       |   |   |
| Purchased power                                                                                                                                                                                                                      |       | 3,823                      |       | 2,798 |   |
| Other                                                                                                                                                                                                                                |       | 3,603                      |       | 2,679 |   |
| Purchased power cost subject to refund                                                                                                                                                                                               |       | 4,376                      |       | 203 |   |
| Accrued and other current liabilities (Note  14)                                                                                                                                                                                     |       | 3,202                      |       | 3,902 |   |
| Current income tax payable (Note 23)                                                                                                                                                                                                 |       | —                     |       | 562 |   |
| **Total current liabilities**                                                                                                                                                                                                        |       | 25,009                     |       | 28,967 |   |
|                                                                                                                                                                                                                                 |       |                       |       |   |   |
| **Long-Term Debt, Net of Current Portion:**                                                                                                                                                                                          |       |                       |       |   |   |
| Mortgage notes (Note 11)                                                                                                                                                                                                             |       | 133,873                    |       | 143,188 |   |
| Note payable and other capital leases (Notes  12 and 13)                                                                                                                                                                             |       | 159                        |       | 184 |   |
| **Total long-term debt**                                                                                                                                                                                                             |       | 134,032                    |       | 143,372 |   |
|                                                                                                                                                                                                                                 |       |                       |       |   |   |
| **Deferred Credits (Note 16)**                                                                                                                                                                                                       |       | 5,294                      |       | 3,677 |   |
|                                                                                                                                                                                                                                 |       |                       |       |   |   |
| **Stockholders’ Equity:**                                                                                                                                                                                                       |       |                       |       |   |   |
| Preferred stock, par value $1 per share,  50,000,000 shares authorized, no shares issued or outstanding                                                                                                                              |       | —                     |       | — |   |
| Common stock, par value $.01 per share,  50,000,000 shares authorized, 1,733,835 shares issued and 1,617,640 shares  outstanding at December 31, 2004 and 1,650,395 issued and 1,567,725  outstanding at December 31, 2003 |       | 17                         |       | 17 |   |
| Paid in capital                                                                                                                                                                                                                      |       | 13,656                     |       | 11,641 |   |
| Retained earnings                                                                                                                                                                                                                    |       | 25,407                     |       | 19,974 |   |
| Less Deferred compensation                                                                                                                                                                                                           |       | (1,973                     | )          | (3,826 | ) |
| Less Treasury stock of 116,195 and 82,670  shares at December 31, 2004 and 2003, respectively                                                                                                                                   |       | (1,755                     | )          | (833 | ) |
| **Total stockholders’ equity**                                                                                                                                                                                                  |       | 35,352                     |       | 26,973 |   |
| **Total Liabilities and Stockholders’ Equity**                                                                                                                                                                                  |       | $                          | 199,687    |   | $ | 202,989 |   |

** **

**The accompanying notes are an integral part of these consolidatedfinancial statements.**

** **

**F-4**

----

** **

**CAP ROCK ENERGY CORPORATIONCONSOLIDATED STATEMENTS OFEQUITY**

 
| ** **                                                                                                      |   | **(Thousands of dollars except number of shares)** |   |
|-----------------------------------------------------------------------------------------------------------------|--------|----------------------------------------------------|--------|
| ** **                                                                                                      |   | **Successor**                                      |   |   |   | **Patronage Capital** |   | **Total** |   |
| ** **                                                                                                      |   |                                               |   |   |   |   |   |   |   | **Total** |   | **Other** |   | **Obligated to be** |   | **Margins** |   |
| ** **                                                                                                      |   | **Common Stock**                                   |   | **Paid in** |   | **Retained** |   | **Stockholders’** |   | **Equities and** |   | **converted to** |   | **and** |   |
| ** **                                                                                                      |   | **# shares**                                       |   | **Value** |   | **Capital** |   | **Earnings** |   | **Equity** |   | **Margins** |   | **Shareholder Equity** |   | **Equities** |   |
| **Balance, December 31, 2001**                                                                             |   | 1,302,355                                          |   | $ | 13 |   | $ | (13 | ) | $ | — |   | $ | — |   | $ | (4,718 | ) | $ | 12,390 |   | $ | 7,672 |   |
| Issuance of the Company’s common stock to the  Cooperative in exchange for its net assets and liabilities  |   |                                               |   |   |   | (4,718 | ) |   |   | (4,718 | ) | 4,718 |   |   |   | 4,718 |   |
| Conversion costs                                                                                                |   |                                               |   |   |   | (1,685 | ) |   |   | (1,685 | ) |   |   |   |   |   |   |
| Distribution by the Cooperative of shares of the  Company’s common stock to the Cooperative’s members |   |                                               |   |   |   | 12,390 |   |   |   | 12,390 |   |   |   | (12,390 | ) | (12,390 | ) |
| Payments to former Cooperative members for fractional  shares and other redemption equity                       |   |                                               |   |   |   | (25 | ) |   |   | (25 | ) |   |   |   |   |   |   |
| Net income                                                                                                      |   |                                               |   |   |   |   |   | 8,776 |   | 8,776 |   |   |   |   |   |   |   |
| **Balance, December 31, 2002**                                                                             |   | 1,302,355                                          |   | 13 |   | 5,949 |   | 8,776 |   | 14,738 |   | — |   | — |   | — |   |
|                                                                                                                 |        |                                                    |        |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |

** **

**The accompanying notes are an integral part of these consolidatedfinancial statements.**

** **

**F-5**

----

 
| ** **                                                                                                              |   |             |   |        |   |         |   |         |   |               |   |                   |   |      |   | **Total**  |   |
|-------------------------------------------------------------------------------------------------------------------------|--------|------------------|--------|-------------|--------|--------------|--------|--------------|--------|--------------------|--------|------------------------|--------|-----------|--------|------------|--------|
| ** **                                                                                                              |   | **Common Stock** |   | **Paid in** |   | **Retained** |   | **Deferred** |   | **Treasury Stock** |   | **Stockholders’** |   |
| ** **                                                                                                              |   | **# shares**     |   | **Value**   |   | **Capital**  |   | **Earnings** |   | **Compensation**   |   | **# of Shares**        |   | **Value** |   | **Equity** |   |
| **Balance, December 31, 2002**                                                                                     |   | 1,302,355        |   | 13          |   | 5,949        |   | 8,776        |   |               |   |                   |   |      |   | 14,738     |   |
| Repurchase of shares through tender offer                                                                               |   |             |   |        |   |         |   |         |   |               |   | (82,140                | )      | (821      | )      | (821       | )      |
| Stock awarded through Stock Incentive Plan, net of  shares withheld for taxes and amortization of deferred compensation |   | 348,940          |   | 4           |   | 5,720        |   |         |   | (3,818             | )      |                   |   |      |   | 1,898      |   |
| Unvested shares forfeited                                                                                               |   | (900             | )      |        |   | (9           | )      |         |   | (8                 | )      |                   |   |      |   | (9         | )      |
| Repurchase of common stock                                                                                              |   |             |   |        |   |         |   |         |   |               |   | (260                   | )      | (9        | )      | (9         | )      |
| Adjustment to original converson distribution                                                                           |   |             |   |        |   | (19          | )      |         |   |               |   | (270                   | )      | (3        | )      | (22        | )      |
| Net income                                                                                                              |   |             |   |        |   |         |   | 11,198       |   |               |   |                   |   |      |   | 11,198     |   |
| **Balance, December 31, 2003**                                                                                     |   | 1,650,395        |   | 17          |   | 11,641       |   | 19,974       |   | (3,826             | )      | (82,670                | )      | (833      | )      | 26,973     |   |
| ** **                                                                                                              |   |             |   |        |   |         |   |         |   |               |   |                   |   |      |   |       |   |
| Stock awarded through Stock Incentive Plan, net of  shares withheld for taxes and amortization of deferred compensation |   | 81,050           |   |        |   | 2,024        |   |         |   | 1,870              |   | (31,500                | )      | (850      | )      | 3,027      |   |
| Stock awarded through Stock for Compensation Plan                                                                       |   | 5,790            |   |        |   | 64           |   |         |   |               |   |                   |   |      |   | 64         |   |
| Unvested shares forfeited                                                                                               |   | (3,400           | )      |        |   | (73          | )      |         |   | (17                | )      |                   |   |      |   | (73        | )      |
| Repurchase of common stock                                                                                              |   |             |   |        |   |         |   |         |   |               |   | (2,025                 | )      | (72       | )      | (72        | )      |
| Net income                                                                                                              |   |             |   |        |   |         |   | 5,433        |   |               |   |                   |   |      |   | 5,433      |   |
| **Balance, December 31, 2004**                                                                                     |   | 1,733,835        |   | $           | 17     |         | $      | 13,656       |   | $                  | 25,407 |                   | $      | (1,973    | )      | (116,195   | )      | $ | (1,755 | ) | $ | 35,352 |   |
|                                                                                                                         |        |                  |        |             |        |              |        |              |        |                    |        |                        |        |           |        |            |        |  |  |  |  |  |  |

** **

**The accompanying notes are an integral part of these consolidatedfinancial statements.**

** **

**F-6**

----

** **

**CAP ROCK ENERGY CORPORATIONCONSOLIDATED STATEMENTS OFCASH FLOWS**

** **
| ** **                                                                         | ** ** | **YEAR ENDED DECEMBER 31,** | ** ** |
|------------------------------------------------------------------------------------|------------|----------------------------------|------------|
| ** **                                                                         | ** ** | **2004**                         | ** ** | **2003** | ** ** | **2002** | ** ** |
| ** **                                                                         | ** ** | **(Thousands of dollars)**       | ** ** |
| **Cash Flows From Operating Activities:**                                          |       |                             |       |   |   |   |   |
| Net income                                                                         |       | $                                | 5,433      |   | $ | 11,198 |   | $ | 8,776 |   |
| Adjustments to reconcile net income to net  cash provided by operating activities: |       |                             |       |   |   |   |   |
| Depreciation and amortization                                                      |       | 7,416                            |       | 9,709 |   | 8,953 |   |
| Amortization of debt issue costs                                                   |       | 896                              |       | 1,063 |   | 300 |   |
| Noncash deferred compensation expense                                              |       | 3,804                            |       | 2,020 |   | — |   |
| Write off of investments in proposed  acquisitions                                 |       | —                           |       | — |   | 1,357 |   |
| Equity earnings in Map                                                             |       | —                           |       | (144 | ) | (115 | ) |
| Loss on equity method investment value                                             |       | —                           |       | 1,056 |   | — |   |
| Change in:                                                                         |       |                             |       |   |   |   |   |
| Other assets/deferred credits                                                      |       | 1,617                            |       | (1,756 | ) | 5,909 |   |
| Accounts receivable                                                                |       | 1,127                            |       | (3,811 | ) | (921 | ) |
| Income tax receivable                                                              |       | (3,986                           | )          | — |   | — |   |
| Purchased power cost subject to refund                                             |       | 4,173                            |       | 3,704 |   | (3,888 | ) |
| Other current assets                                                               |       | (446                             | )          | (1,059 | ) | (6,386 | ) |
| Accounts payable and accrued expenses                                              |       | 1,314                            |       | 1,284 |   | (735 | ) |
| Net cash provided by operating activities                                          |       | 21,348                           |       | 23,264 |   | 13,250 |   |
| **Cash Flows From Investing Activities**                                           |       |                             |       |   |   |   |   |
| Utility plant additions                                                            |       | (4,583                           | )          | (5,209 | ) | (1,517 | ) |
| Proceeds from liquidation of investments                                           |       | 913                              |       | 1,511 |   | 1,043 |   |
| Issuance of notes receivable                                                       |       | (1,586                           | )          | (1,250 | ) | — |   |
| Collection of notes receivable                                                     |       | 1,250                            |       | 12,490 |   | 1,000 |   |
| Net cash provided by (used in) investing  activities                               |       | (4,006                           | )          | 7,542 |   | 526 |   |
| **Cash Flows From Financing Activities:**                                          |       |                             |       |   |   |   |   |
| Proceeds from other long-term debt and  capital leases                             |       | 113                              |       | 14,169 |   | 534 |   |
| Payments on mortgage notes                                                         |       | (3,966                           | )          | (3,704 | ) | (3,034 | ) |
| Payments on other long-term debt and  capital leases                               |       | (136                             | )          | (30,246 | ) | (6,387 | ) |
| Payment of short-term note payable                                                 |       | (14,169                          | )          | — |   | — |   |
| Debt issuance costs                                                                |       | (3,632                           | )          | (1,208 | ) | — |   |
| Restricted cash investment                                                         |       | 14,169                           |       | (5,962 | ) | — |   |
| Repurchase/acquisition of common stock                                             |       | (923                             | )          | (852 | ) | — |   |
| Retirement of former member equity                                                 |       | —                           |       | (732 | ) | (488 | ) |
| Net cash used in financing activities                                              |       | (8,544                           | )          | (28,535 | ) | (9,375 | ) |
| **Increase (Decrease) in Cash and Cash  Equivalents:**                             |       | 8,798                            |       | 2,271 |   | 4,401 |   |
| Cash at beginning of year                                                          |       | 12,170                           |       | 9,899 |   | 5,498 |   |
| Cash at end of year                                                                |       | $                                | 20,968     |   | $ | 12,170 |   | $ | 9,899 |   |
| **Noncash financing activities:**                                                  |       |                             |       |   |   |   |   |
| Deferred compensation related to stock  awards                                     |       | $                                | 471        |   | $ | 3,695 |   | $ | — |   |
| **Supplemental Cash Flow Information**                                             |       |                             |       |   |   |   |   |
| Cash paid during the year for interest                                             |       | $                                | 7,045      |   | $ | 6,640 |   | $ | 8,611 |   |
| Cash paid during the year for income taxes                                         |       | $                                | 1,450      |   | $ | 1,950 |   | $ | — |   |

** **

**The accompanying notes are an integral part of these consolidatedfinancial statements.**

** **

**F-7**

----

** **

**CAP ROCKENERGY CORPORATIONNOTES TO CONSOLIDATEDFINANCIAL STATEMENTSDECEMBER 31, 2004, 2003 AND 2002**

** **

**1.  SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES**

** **

**General**

** **

**Cap Rock EnergyCorporation, Inc. (the “Company” or the “Successor”) was formed in December 1998in accordance with a conversion plan to reorganize a member owned electriccooperative, Cap Rock Electric Cooperative, Inc. (the “Cooperative” or the “Predecessor”)to a shareholder owned business corporation.  The Cooperative was incorporated as an electric cooperative in the Stateof Texas in 1939 to provide electric distribution services and power to itsmembers.  The Company currently providesservice to approximately 35,000 meters in 28 counties covering approximately13,000 square miles in Texas.  Itscustomers, which are principally residential, commercial and irrigation, arelocated in the Midland-Stanton area of west Texas, the central Texas areaaround Brady, and in northeast Texas in Hunt, Collin and Fannin Counties.  Through its subsidiaries, the Company is alsoengaged in the transmission of electricity through a looped system 305 miles inlength, and in providing various electric and nonelectric services tocustomers.**

** **

**Presentationand Principles of Consolidation**

** **

**The accompanyingconsolidated financial statements include the accounts of the Company, Cap RockEnergy Corporation (“Energy”) and its wholly-owned subsidiaries, NewCorpResources Electric Cooperative, Inc. (“NewCorp”), Cap Rock Cooperative FinanceCorporation (“CRCFC”), Capstar Communications, Petra One Energy, L.P., PetraEnergy, LLC and the Cooperative.  TheCooperative was dissolved in March 2004. Energy and NewCorp maintain accounting records in accordance with theuniform system of accounts, as prescribed by the Federal Energy RegulatoryCommission (“FERC”).**

** **

**All significantintercompany balances and transactions have been eliminated inconsolidation.  Unless otherwiseindicated, all references to the Company will include any and all activities ofits Predecessor.**

** **

**Use ofEstimates**

** **

**In conformity withaccounting principles generally accepted in the United States, the preparationof the Company’s consolidated financial statements requires management to makeestimates and assumptions with respect to values or conditions which cannot beknown with certainty, that affect the recorded amounts of assets andliabilities, disclosure of contingent assets and liabilities and the recordedamounts of revenues and expenses.  Actualresults could differ from those estimates. Items which may be estimated include, but are not limited to, theeconomic useful lives of assets, fair values of assets and liabilities,impairment of goodwill, obligations under employee benefit plans, valuationallowances for receivables and deferred tax assets, unbilled revenues fordistribution services and electricity provided for which meters have not beenread, and various other recorded or disclosed amounts.**

** **

**RegulatoryAccounting**

** **

**The Company’s principalbusiness is the transmission and distribution of electricity through NewCorpand Energy, respectively.  NewCorp issubject to regulation by the Federal Energy Regulatory Commission, and Energyis now regulated by the Public Utility Commission of Texas (“PUCT”).  Accordingly, the Company accounts for theeffects of regulation pursuant to SFAS No. 71, “Accounting for the Effects ofCertain Types of Regulation.”  Thisstatement applies to the financial statements of an entity that has rates that(1) are approved by  a bodyempowered  to  set rates that  bind customers, (2)  are cost-based, and (3) can be charged to and**

** **

**F-8**

----

** **

**collected fromcustomers.  If an entity meets the abovethree criteria, it is required to capitalize costs that would otherwise becharged to expense if the actions of the regulating body make it probable thatthose costs will be recovered through rates in future periods.  These capitalized costs are classified as regulatoryassets.  SFAS No. 71 also requires therate-regulated entity to assess the recoverability of regulatory assetsreflected on its balance sheet.  Regulatory liabilities represent probable future reductions in revenuesassociated with amounts that are expected to be credited to customers throughthe rate making process.**

** **

Thesignificant regulatory assets and liabilities are as follows:

 
| ** **                                                                                 | ** ** | **2004**  | ** ** | **2003** | ** ** |
|--------------------------------------------------------------------------------------------|------------|-----------|------------|----------|------------|
| **Assets:**                                                                                |       |      |       |     |       |
| Rate case  costs                                                                           |       | $         | 3,593,000  |     | $          | 145,000 |   |
|                                                                                       |       |      |       |     |       |
| **Liabilities:**                                                                           |       |      |       |     |       |
| Purchased  power subject to refund                                                         |       | 4,373,000 |       | 203,000  |       |
| Excess  recovery of costs related to transfer of Certificate of Convenience and  Necessity |       | 723,000   |       | 704,000  |       |
|                                                                                            |            |           |            |          |            |  |  |

 

TheCompany will be allowed to recover certain rate case costs over a periodmandated by the PUCT.  Any costs notallowed for recovery will be expensed immediately.  A decision from the PUCT concerning theamount and period of recovery is expected in June 2005.

 

Bothregulatory liabilities are expected to be refunded to customers within 12months.

 

**Earnings PerShare**

** **

**Basic earnings per commonshare is computed by dividing net income by the weighted average number ofcommon shares outstanding.  Dilutedearnings per common share is computed by dividing net income by the weightedaverage number of common shares plus the dilutive impact of stock options,warrants and deferred compensation arrangements which were outstanding duringthe period calculated by the treasury stock method.**

** **

**Cashand Cash Equivalents**

** **

**The Company considersall unrestricted highly liquid investments purchased with original maturitiesof three months or less to be cash equivalents. The carrying amount of cashequivalents approximates market value due to the short-term maturity of theseinvestments.**

** **

**RestrictedCash Investment**

** **

**At December 31,2003, the Company was required to maintain a restricted cash investment of$14,169,000 which served as collateral for the initial advance from Beal BankS.S.B.   Terms of the loan agreementprovided for investment of the cash collateral only in certain specified typesof investments.  Interest earned was notrestricted, and was not classified as restricted.   The initial advance was repaid in November 2004,with funds from the collateralized restricted cash investment used to satisfythe debt payment.  See Note 12.**

** **

**F-9**

----

** **

**Allowancefor Doubtful Accounts**

** **

**The Company provides anallowance for doubtful accounts receivable that are estimated to beuncollectible based on historical trends for each rate class.  As of December 31, 2004 and 2003, theallowance for doubtful accounts was $115,000 and $78,000, respectively. Baddebt expense for the years ended December 31, 2004, 2003 and 2002, was$143,000, $113,000 and $120,000, respectively.**

** **

**Inventories**

** **

**Although the Companyutilizes an independent third party for its materials warehousing function,inventories owned and on hand are primarily transmission parts and materialswhich are not normally stocked by the warehousing company; supplies andmaterials maintained on service trucks; and materials at various remote fieldlocations.  Inventories are valued athistorical cost, at the lower of cost or market.**

** **

**Investmentsand Notes Receivable**

** **

**The Company accountsfor its investments under the cost basis method of accounting if the investmentis less than 20% of the voting stock of the investee, or under the equitymethod of accounting if the investment is greater than 20% of the voting stockof the investee.   Investments accountedfor under the cost method are recorded at their initial cost, and any dividendsor distributions received are recorded in income.   For equity method investments, the Companyrecords its share of earnings or losses of the investee during the period.  Recognition of losses will be discontinuedwhen the Company’s share of losses equals or exceeds its carrying amount of theinvestee plus any advances made or commitments to provide additional financialsupport.**

** **

An investment is considered impaired if the fair value of theinvestment is less than its cost. Generally, an impairment is considered other-than-temporary unless (i)the Company has the ability and intent to hold an investment for a reasonableperiod of time sufficient for an anticipated recovery of fair value up to (orbeyond) the cost of the investment; and (ii) evidence indicating that the costof the investment is recoverable within a reasonable period of time outweighsevidence to the contrary.  If impairmentis determined to be other-than-temporary, then an impairment loss is recognizedequal to the difference between the investment’s cost and its fair value.

** **

**The Company hasinvestments in associated organizations that relate primarily to requiredmembership certificates and accumulated capital allocations, all of which areaccounted for using the cost method of accounting.  Capital allocations for the two primaryinvestees, National Rural Utilities Cooperative Finance Corporation (“CFC”) andTexas Electric Cooperative, Inc. (“TEC”), are determined annually by therespective organizations based on their bylaws, operating margins, cashpositions and various other factors.  TheCompany recognizes capital allocations from the respective organization asincome when it is declared by each respective organization.  CFC is the Company’s primary lender and TECprovides various lobby services for electric cooperatives in Texas.**

** **

**UtilityPlant**

** **

**Utility plant is statedat the original cost of construction, including direct labor, materials,contracted services, payroll taxes and related payroll burdens, andoverhead.  Contributions in aid ofconstruction are credited to the applicable utility plant accounts.  Gains or losses resulting from retirements orother dispositions of utility property in the normal course of business arecredited or charged to the accumulated provision for depreciation.  The cost of maintenance, repairs and minorreplacements are charged to operations as incurred.    The Company does not accrue any cost inadvance for major maintenance or repair projects or the cost of removal.**

** **

**Depreciation isprovided on the following annual rates:**

** **
| Transmission plant         |   | 3.1% - 10 | %      |
|----------------------------|--------|-----------|--------|
| Distribution plant         |   | 3.1       | %      |
| General plant:             |   |      |   |
| Structure and improvements |   | 2.5% - 10 | %      |
| Transportation             |   | 33        | %      |
| Equipment                  |   | 33        | %      |
| Other                      |   | 1.4% - 2  | %      |
| Software costs             |   | 20        | %      |

** **

**F-10**

----

** **

**NonutilityProperty**

** **

**Nonutility property isreal estate, primarily an office building, and investments in real estatepartnerships not principally used in the Company’s core business of electricdistribution.  Prior to their sale in February 2004,the Company’s limited partner investment in real estate partnerships wasincluded also.  All nonutility propertyexcept real estate partnerships is stated at original cost. Maintenance,repairs and miscellaneous replacements and renewals of this type of nonutilityproperty are charged to operations as incurred. The majority of depreciation isprovided on a straight line basis over estimated useful lives, which range from15 to 30 years.**

** **

**Income and expensesrelated to the Company’s primary real estate property are recognized on anaccrual basis.  The investments in realestate partnerships were accounted for under the cost basis method ofaccounting because the Company’s ownership was less than 10% in each case.  Income from the Company’s miscellaneous realestate partnership investments is recognized as income was received.  These investments were sold in February 2004.**

** **

**Impairment ofLong-Lived Assets**

** **

**The Company’s policy isin accordance with SFAS No. 144, “Accounting for the Impairment or Disposal ofLong-Lived Assets,” whereby long-lived assets are reviewed for impairmentwhenever events or changes in circumstances indicate that the carrying amountof an asset may not be recoverable. Recoverability of assets to be held and used is measured by a comparisonof the carrying amount of an asset to estimated undiscounted future cashinflows expected to be generated by the asset. If the carrying amount of an asset exceeds its estimated undiscounted futurecash flows, an impairment charge is recognized for the amount by which thecarrying amount exceeds the fair value of the asset.**

** **

**Goodwilland Intangible Assets**

** **

**Goodwill is reviewedannually as of December 31 for impairment or whenever events and changes incircumstances occur that may reduce the fair value below the carryingvalue.  No impairment has been necessarybecause the fair value of the recorded goodwill has exceeded the carryingvalue.**

** **

**In connection with theconversion in 2002 of the line of credit with CFC into a long term mortgagenote, the Company was required to pay a conversion fee.  This is being amortized over the life of thenew debt, which is 6 years.**

** **

**The Company capitalizedcosts it incurred in connection with the financing arrangements with Beal BankS.S.B.  The terms of the initial advancewith the bank provided for a due date of September 9, 2004, and because itwas not certain that the Company would draw on the additional advance, thefinancing costs were being amortized over the 12 month period of the initialadvance.   The initial advance was repaidin November  2004.   See also Note12.**

** **

**The Company has othermiscellaneous intangible assets that are not deemed to have indefinitelives.  These assets will continue to beamortized over their estimated useful lives, which range from 3 to 10years.  See Note 10.**

** **

**F-11**

----

** **

**CapitalizedInterest**

** **

**The Company capitalizesinterest cost to construction work in progress calculated in accordance withSFAS No. 34, “Capitalization of Interest Cost.”**

** **

**Equitiesand Margins of the Cooperative**

** **

**As of December 31,2001, the Cooperative’s equities and margins consisted only of amounts thatwere obligated to be converted into shareholder equity.**

** **

**RevenueRecognition**

** **

Forall periods through December 31, 2002, the Company recorded revenue on thebasis of meters read and billed to customers. This was pursuant to the rate-making policy as set by the Company’sBoard of Directors.  The accrual methodrecognizes revenue when the service and power have been delivered to thecustomer.  Had the Company recordedrevenue on an accrual basis, a regulatory liability would have existed becauseit was not entitled to recognize revenue until the customers had been billed.  In the utility industry, the rate-makingpolicy defines the accounting requirements according to SFAS No. 71.

 

**Effective January 1, 2003, the Company’s Boardof Directors revised the rate-making policy to recognize unbilled revenue.  Therefore, the Company was required to changeaccounting principles.  Under the newrate-making structure, the Company records revenue based on amounts billed tocustomers as well as unbilled amounts based upon an estimate of the revenuesfor energy and service delivered since the latest billing through the end of theperiod.  The effect of the change for2003 was to increase electric revenues by $3,400,000, and increase purchasedpower by $1,318,000, for a net increase in income before income taxes of$2,082,000.**Unrecognized, unbilled electric revenues as of December 31,2002, were approximately $2,521,000, respectively.

** **

**Other operating  revenue consists primarily of fees fromcustomers for items such as late payment penalties and connection services, aswell as building rental income which is accrued monthly based on contractuallease obligations.**

** **

**PurchasedPower Costs**

** **

**The Company accrues itspurchased power cost based on actual usage for the respective period.**

** **

**The Company’s currenttariffs for electric service include power cost recovery clauses under which electricrates charged to retail customers are adjusted monthly to collect actualpurchased power costs incurred in providing service. The over or undercollection is reflected in the balance sheet as Purchased power subject torecovery or refund.  In connection withits review of the Company’s proposed tariffs for retail service, the PUCT mayrequire the Company to change to a fixed fuel factor method for billingcustomers, subject to annual reconciliations of actual power cost incurred toactual fuel revenues collected.**

** **

**In September 2001,the Company determined that approximately $1,700,000 of collected powerrecovery costs subject to refund represented billable costs to customers and asa result, recorded an adjustment to reduce purchased power costs and thepurchased power subject to refund account. This amount was reflected in thepower recovery costs subject to refund liability.  In January 2002, the Company determinedthat approximately $4,360,000, inclusive of the $1,700,000 described above, ofpower costs incurred and expensed in periods prior to 2002 were recoverablecosts.  These costs were approved by theBoard to be recovered through future**

** **

**F-12**

----

** **

**billings to customersover a 24 month period beginning in January 2002, and ending in December 2003.  This created a regulatory asset, purchasedpower costs subject to recovery, and a regulatory liability, deferred revenue.**

** **

**During the rate caseproceedings in the fall of 2004, the Company determined that power costs of$3,074,000 had been overcollected under the Company’s retail tariffs throughthe power cost recovery process.  Aregulatory liability was recorded for this overcollection, and the overrecovery was disclosed to the PUCT. These monies are currently being returned to customers through powercost recovery refunds.  As of December 31,2004, $480,000 had been  returned tocustomers.   Legal issues regarding thisover recovery and the method and timing of refunding it are being discussedwith the PUCT Staff, and the ultimate outcome is unknown.  In addition, the Company believes rate casecosts of $3,593,000 will be fully allowed, and this recovery will also offsetthe power cost recovery overcollection, making the payout to customers cashneutral, with no economic effect to the Company’s statement of operations.  However, this is also subject to PUCTapproval.   See Note 22.**

** **

**Stock BasedCompensation**

** **

**Effective January 1,2003, the Company adopted the fair value method of accounting for its employeestock incentive plan in accordance with SFAS No. 123, “Accounting forStock-Based Compensation,” as amended by SFAS No. 148, “Accounting forStock-Based Compensation, Transition and Disclosure.”  Under the historical or retroactivetransition method allowed by SFAS No. 148, the compensation expense for theyear ended December 31, 2002, would not have been different had the fairvalue method been originally applied. See also Note 15.**

** **

**IncomeTaxes**

** **

**The Company accountsfor income taxes under the asset and liability method of accounting for incometaxes.  Under this method, deferredincome taxes are recognized for the estimated future tax consequences of “temporarydifferences” by applying enacted statutory tax rates for each taxablejurisdiction applicable to future years to differences between the financialstatement carrying amounts and the tax basis of existing assets andliabilities.   The Company records avaluation allowance to reduce its deferred tax assets to the extent it is morelikely than not that such deferred tax assets will not be realized.  The effect on deferred tax assets andliabilities of a change in tax rate is recognized in income in the period thatincludes the enactment date.**

** **

**The Cooperative andNewCorp are tax-exempt organizations under Internal Revenue Code Section 501(c)(12).  Upon conversion to a shareholder ownedbusiness corporation, the activities and transactions formerly performed by theCooperative became taxable.  Energy andCapstar are taxable organizations for Internal Revenue Service purposes andfile a consolidated federal income tax return. CRCFC is a taxable organization for Internal Revenue Service purposesand files a separate federal income tax return.   The Cooperative was dissolved in March 2004and has filed a final tax return.**

** **

**DerivativeInstruments**

** **

**The Company may usederivative instruments to manage the natural gas component of power costs,which minimize the fluctuations in customers’ power bills.  All payments made or received in connectionwith these types of transactions will be collected from or rebated to customersthrough the power cost recovery component of the customers’ power bills.  The fair market value of these instruments isrecorded as an asset or liability with a corresponding regulatory liability orregulatory asset, as all amounts paid or received will be passed through to theCompany’s customers.  As of December 31,2004 or 2003, no derivative position was held.**

** **

**F-13**

----

 

**New Accounting Standards**

 

In December 2004, the FASB issued SFAS No. 123R, “Share-BasedPayment.”  SFAS No. 123R revises SFAS No.123, “Accounting for Stock-Based Compensation.” This new standard generally requires the cost associated with employeeservices received in exchange for an award of equity instruments be measuredbased on the grant-date fair value of the award and recognized in the financialstatements over the period during which the employee is required to provideservices in exchange for the award.  SFASNo. 123R also provides guidance on how to determine the grant-date fair valuefor awards of equity instruments, as well as alternative methods of adoptingits requirements.  SFAS No. 123R iseffective as of the beginning of the first interim or annual reporting periodafter June 15, 2005, and applies to all outstanding and unvestedshare-based payment awards at a company’s adoption date.  The Company changed its method of accountingfrom the intrinsic method per APB Opinion No. 25, to the fair value method perSFAS No. 148, effective January 1, 2003. Therefore, SFAS No. 123R is not expected to have an impact on theCompany’s consolidated financial statements.

 

In May 2004, the Financial Accounting Standards Board issued StaffPosition No. 106-2, “Accounting and Disclosure Requirements Related to theMedicare Prescription Drug, Improvement and Modernization Act of 2003” (“FSP106-2”).   FSP 106-2 permits a sponsor ofa postretirement health care plan that provides a prescription drug benefit to makea one-time election to defer accounting for the effects of the Medicare Act andrequires certain disclosures pending determination as to whether the sponsor’spostretirement health care plan reasonably expect to qualify for beneficialtreatment under the Act.  See Note 15 forquantification.

 

**OtherComprehensive Income**

** **

**There were no itemsof comprehensive income for any period presented.**

** **

**Reclassifications**

** **

**Certainreclassifications have been made to prior periods’ financial statements toconform to the presentation adopted in the current period.**

** **

**2.  CORPORATE CONVERSION**

** **

**On October 20,1998, the Cooperative’s members adopted a conversion plan to reorganize theCooperative from a member owned electric cooperative to a shareholder ownedbusiness corporation.  In connection withthe conversion plan, Cap Rock Energy Corporation was formed in December 1998as a subsidiary of the Cooperative and substantially all of the Cooperative’soperational activities were transferred to Energy.  Energy registered shares of its common stockwith the Securities and Exchange Commission as of February 8, 2002, andthey were distributed to the Cooperative’s members and holders of equityaccounts that chose that option. On March 14, 2002, the common stock ofEnergy was approved for listing on the American Stock Exchange. See Note 3concerning the Company’s related repurchase offer.  The Cooperative was then dissolved in March 2004.**

** **

**Energy’s Articles ofIncorporation provide that any shareholder or affiliate of a shareholder holdingin excess of 5% of Energy’s outstanding common stock will have its votingrights for those shares in excess of 5% reduced to 1/100 per share.**

 

F-14

----

 

**3.  REPURCHASE OFFER**

** **

Sharesof the Company’s common stock were originally distributed to certain formermembers of the Cooperative who elected to receive shares of stock as paymentfor their equity and membership interest in the Cooperative.  Pursuant to the conversion plan, the Companymade a commitment to purchase those shares, held continuously by the originalowners of record until the first anniversary of the distribution of the sharesat a price of $10 per share if the Company had sufficient cash available topurchase all shares tendered.  The Company’soriginal purchase commitment was only to those shareholders who were theoriginal holders of record, and who had held those shares continuously untilthe first anniversary of the distribution of the shares.  In an effort to be inclusive, rather thanexclusive, the Company made the offer to all shareholders and extended theoffering period beyond the original 60 days. The offering period began February 5, 2003, and ended April 30,2003, with 82,140 shares of common stock tendered to and accepted by theCompany at $10 per share, totaling $821,400. At December 31, 2003, such amount is shown in Treasury stock withinthe Stockholders’ Equity section of the consolidated balance sheet.  There are no further obligations related tothe Company’s repurchase commitment.

 

**4.UNSUCCESSFUL LAMAR ACQUISITION**

** **

InOctober 1999, the Cooperative entered into an agreement (“CombinationAgreement”) with Lamar County Electric Cooperative Association (“Lamar”),pursuant to which Lamar was to combine with, and become an operating divisionof, the Cooperative.  The members ofLamar subsequently approved this Combination Agreement.  The agreement provided that if thecombination was terminated by Lamar, with certain specific allowableexceptions, Lamar was required to reimburse the Cooperative for all costs andexpenses it had incurred, whether paid to outside parties or incurredinternally, with respect to the combination. The completion of the combination was delayed because of litigation withLamar’s power supplier. The power supplier claimed that Lamar and theCooperative had each breached various agreements.

 

OnAugust 29, 2000, the Cooperative and Lamar entered into a five yearManagement Service Agreement.  Under theterms of that agreement, Lamar’s Board of Directors continued to set policy andperform all of its fiduciary responsibilities, and the Cooperative performedcertain management services for Lamar. As compensation for its management services, the Cooperative (subsequentlythe Company) received $1,000 per month plus reimbursed costs and expenses.  One of the terms of the agreement providedthat if Lamar terminated the agreement prior to the expiration of the originalterm, Lamar would be required to pay a cancellation fee of $300,000 asliquidated damages.

 

Lamar terminated the Combination Agreement in October 2002 and theManagement Service Agreement in November 2002.  Lamar filed suit against the Company seekinga declaratory judgment that it had the right to terminate both agreementswithout regard to payment of any kind to the Company.  The Company believes that Lamar’sstated reason for termination of the Combination Agreement does not fall withinthe specific allowable exceptions set forth in the agreement, and therefore theCompany believes it is entitled to reimbursement of all costs and expensesincurred.  The Company is also seekingthe specified liquidated damages fee of $300,000 in connection with thetermination of the Management Service Agreement.

 

BecauseLamar terminated the Combination Agreement, generally accepted accountingprinciples required the impairment of previously capitalized costs that wereincurred in connection with the combination. The majority of these costs were outside legal and consulting fees.  At December 31, 2002, these costs,aggregating  $1,357,000, were expensedand are shown on the consolidated statement of operations.

 

F-15

----

 

**5.  EARNINGS PER SHARE INFORMATION**

** **

**The following tableshows the reconciliation of basic and diluted earnings per share:**

** **
| ** **                                                            | ** ** | **YEAR ENDED DECEMBER 31,  2004** | ** ** |
|-----------------------------------------------------------------------|------------|----------------------------------------|------------|
| ** **                                                            | ** ** | **Income**                             | ** ** | **Shares** | ** ** | **Per Share** | ** ** |
| ** **                                                            | ** ** | **(In Thousands)**                     | ** ** | ** ** | ** ** | ** ** | ** ** |
| Basic  earings per share:                                             |       |                                   |       |   |   |   |   |
| Income from  continuing operations available for common stock         |       | $                                      | 5,433      |   | 1,546,271 |   | $ | 3.51 |   |
|                                                                  |       |                                   |       |   |   |   |   |
| Effect of  diluted securities:                                        |       |                                   |       |   |   |   |   |
| Shares that  have been deferred under the Stock for Compensation plan |       |                                   |       | 50,525 |   | (0.11 | ) |
|                                                                  |       | $                                      | 5,433      |   | 1,596,796 |   | $ | 3.40 |   |
| Diluted  earnings per share:                                          |       |                                   |       |   |   |   |   |

** **
| ** **                                                            | ** ** | **YEAR ENDED DECEMBER 31,  2003** | ** ** |
|-----------------------------------------------------------------------|------------|----------------------------------------|------------|
| ** **                                                            | ** ** | **Income**                             | ** ** | **Shares** | ** ** | **Per Share** | ** ** |
| ** **                                                            | ** ** | **(In Thousands)**                     | ** ** | ** ** | ** ** | ** ** | ** ** |
| Basic  earings per share:                                             |       |                                   |       |   |   |   |   |
| Income from  continuing operations available for common stock         |       | $                                      | 11,198     |   | 1,455,443 |   | $ | 7.69 |   |
|                                                                  |       |                                   |       |   |   |   |   |
| Effect of  diluted securities:                                        |       |                                   |       |   |   |   |   |
| Shares that  have been deferred under the Stock for Compensation plan |       |                                   |       | 55,298 |   | (0.28 | ) |
|                                                                  |       |                                   |       |   |   |   |   |
| Diluted  earnings per share:                                          |       | $                                      | 11,198     |   | 1,510,741 |   | $ | 7.41 |   |

** **

**Both basic and dilutedearnings per share for the year ended December 31, 2002, are notmaterially different.**

** **

**6.OTHER CURRENT ASSETS**

** **

**Other current assetsas of December 31, 2004 and 2003, consisted of the following (inthousands):**

 

F-16

----

 
| ** **                  | ** ** | **December 31,** | ** ** |
|-----------------------------|------------|-----------------------|------------|
| ** **                  | ** ** | **2004**              | ** ** | **2003** | ** ** |
| ** **                  | ** ** | **(In Thousands)**    | ** ** |
| Inventories                 |       | $                     | 1,333      |   | $ | 939 |   |
| Prepaid  income tax         |       | 3,398                 |       | — |   |
| Prepaid  insurance          |       | 363                   |       | 385 |   |
| Interest  receivable        |       | 91                    |       | 67 |   |
| Other                       |       | 246                   |       | 196 |   |
| Total Other  Current Assets |       | $                     | 5,431      |   | $ | 1,587 |   |

** **

**7.INVESTMENTS AND NOTES RECEIVABLE**

** **

**Investments and notesreceivable as of December 31, 2004 and 2003, consisted of the following(in thousands):**

** **
| ** **                                           | ** ** | **December 31,** | ** ** |
|------------------------------------------------------|------------|-----------------------|------------|
| ** **                                           | ** ** | **2004**              | ** ** | **2003** | ** ** |
|                                                 |       |                  |       |   |   |
| Investments  in associated organizations:            |       |                  |       |   |   |
| CFC capital  term certificates                       |       | $                     | 5,905      |   | $ | 6,210 |   |
| CFC  patronage capital                               |       | 2,569                 |       | 2,543 |   |
| TEC  patronage capital and bonds                     |       | 852                   |       | 852 |   |
| Other                                                |       | 41                    |       | 49 |   |
| Total  investments in associated organizations       |       | 9,367                 |       | 9,654 |   |
|                                                 |       |                  |       |   |   |
| Investment  in United Fuel (Note 14)                 |       | —                |       | 360 |   |
| Note  receivable related to United Fuel stock        |       | 1,300                 |       | — |   |
| Note  receivable related to real estate partnerships |       | 286                   |       | — |   |
| Other  investments                                   |       | 51                    |       | 31 |   |
| Total  Investments and Notes Receivable              |       | $                     | 11,004     |   | $ | 10,045 |   |

** **

**Allocations of incomefrom all associated organizations was $540,000, $530,000 and  $478,000, respectively, for the years ended December 31,2004, 2003 and 2002.**

** **

**In October 2003,the Company sold its 42% interest in Map Resources, Inc. (“MAP”) to MAP inexchange for a note receivable of $1,250,000, due October 8, 2004, withinterest at 6% per annum.  The originalinvestment had been accounted for using the equity method.  The note receivable, shown in Current NotesReceivable at December 31, 2003, was collateralized by the originalstock.  The investment appreciated overthe period that the Company held it, but because the sales price was less thanthe recorded book value on an equity method basis, the Company was required toreflect a loss of $1,056,000 for 2003. The note was repaid in July 2004, and the Company recouped itsoriginal cash investment.  The Company’sequity earnings in MAP for the nine month period ended September 30, 2003,and the year ended December 31, 2002, was $144,000 and  $115,000, respectively.**

** **

**In March 2004, theCompany signed an agreement with a shareholder of United Fuel and EnergyCorporation (“United Fuel”) to sell its shares of stock in that company for asales price of $1,300,000 in exchange for a note receivable.  The terms of the agreement provide:  (a) interest on the note receivable at 6%annum, (b)**

 

F-17

----

 

**payment of $500,000 onthe payment date plus accrued interest, (c) payment of the remaining principalbalance in three equal annual installments plus accrued interest beginning oneyear after the payment date.  The paymentdate is defined as the sooner of 24 months from the date of the agreement or 60days after United Fuel has completed certain capitalization arrangements.  Recognition of the gain of $940,000 has beendeferred until principal payments have been received.  See Note 16. All conditions required pursuant to the agreement have been satisfied,and the Company expects payment as scheduled in 2005.**

** **

**The Company sold itslimited partner interest in real estate partnerships in February 2004, toan unrelated third party in exchange for a note receivable of $286,000 due2009, with interest at 4.5% per annum. The note is collateralized by the partnership interests.  See Note 9.**

** **

**8.UTILITY PLANT**

** **

**Utility plant as of December 31,2004 and 2003, consisted of the following (in thousands):**

** **
| ** **                           | ** ** | **December 31,** | ** ** |
|--------------------------------------|------------|-----------------------|------------|
| ** **                           | ** ** | **2004**              | ** ** | **2003** | ** ** |
|                                 |       |                  |       |   |   |
| Distribution  facilities             |       | $                     | 184,713    |   | $ | 179,250 |   |
| Transmission  facilities             |       | 65,792                |       | 69,051 |   |
| General  facilities                  |       | 9,816                 |       | 9,045 |   |
| Total utility plant                  |       | 260,321               |       | 257,346 |   |
| Less  accumulated depreciation       |       | (111,466              | )          | (105,349 | ) |
| Total utility  plant in service, net |       | 148,855               |       | 151,997 |   |
| Construction  work in progress       |       | 506                   |       | 165 |   |
| Total Utility Plant, net             |       | $                     | 149,361    |   | $ | 152,162 |   |

** **

**As of December 31,2004 and 2003, all utility plant assets, except the transmission facilities,are pledged to collateralize debt and capital lease obligations.**

** **

**9.NONUTILITY PROPERTY**

** **

**Nonutility property asof December 31, 2004 and 2003, consisted of the following (in thousands):**

** **
| ** **                     | ** ** | **December 31,** | ** ** |
|--------------------------------|------------|-----------------------|------------|
| ** **                     | ** ** | **2004**              | ** ** | **2003** | ** ** |
|                           |       |                  |       |   |   |
| Real estate                    |       | $                     | 1,992      |   | $ | 2,278 |   |
| Furniture,  fixtures and other |       | 7                     |       | 7 |   |
| Total nonutility property      |       | 1,999                 |       | 2,285 |   |
| Less  accumulated depreciation |       | (772                  | )          | (740 | ) |
| Total Nonutility Property, net |       | $                     | 1,227      |   | $ | 1,545 |   |

** **

**The Company owns a45,000 square foot office building that is used as its general corporateheadquarters. The Company currently occupies approximately 35% of the buildingand the remainder is leased to commercial tenants, subject to leasing termsranging from monthly to 7 years. For the years ended December 31, 2004,2003 and 2002, third party building rental revenue was $294,000, $258,000 and$286,000, respectively. Building rental**

 

F-18

----

 

**revenues, which are notmaterial to the Company’s operations, for each of the next five years areexpected to be approximately $250,000 per year. As of December 31, 2004and 2003, the net book value of the building and related property was$1,112,000 and $1,141,000, respectively, which is the majority of thenonutility property.**

** **

**The Company sold its limitedpartner interest in real estate partnerships in February 2004, to anunrelated third party in exchange for a note receivable of $286,000 which wascollateralized by the partnership interests. There was no gain or loss recorded on the sale.  In prior years, the Company had guaranteeddebt of some of the partnerships, with the maximum exposure of such guaranteesaggregating $5,178,000 at December 31, 2003.  The sale of the partnership interests alsoinvolved the transfer of those guarantees to the buyer.  Income for each period shown related to thereal estate partnerships has been less than $12,000.**

** **

**10.  REGULATORY AND OTHER ASSETS**

** **

**Other assets as of December 31,2004 and 2003, consisted of the following (in thousands):**

** **
| ** **                                        | ** ** | **December 31,** | ** ** |
|---------------------------------------------------|------------|-----------------------|------------|
| ** **                                        | ** ** | **2004**              | ** ** | **2003** | ** ** |
|                                              |       |                  |       |   |   |
| McCulloch  goodwill, net of amortization          |       | $                     | 199        |   | $ | 199 |   |
| Bank fees,  net of amortization (Notes 12 and 13) |       | 134                   |       | 846 |   |
| Rate case  costs                                  |       | 3,593                 |       | 145 |   |
| Total Other Assets and Deferred Charges           |       | $                     | 3,926      |   | $ | 1,190 |   |

** **

**The McCulloch goodwillrepresents costs incurred in connection with the acquisition of an electriccooperative in 1999, in the amount of $373,000. As of December 31, 2004 and 2003, the accumulated amortization was$174,000.**

** **

**Bank fees are costsof $210,000 incurred in connection with the conversion of the line of credit toa mortgage note.  Accumulatedamortization at December 31, 2004 and 2003, is $76,000 and $30,000.  As of December 31, 2003, bank fees alsoincluded costs of $999,000 related to the refinancing of the transmissionsystem with Beal Bank, S.S.B., with associated accumulated amortization of$333,000.  These costs were fullyamortized and retired because the loan was effectively repaid in November 2004.  See also Notes 11 and 12.**

** **

**Rate case costs arethird party costs incurred to prepare the rate filing package, as well as thepublic hearing process.  These costs areregulatory assets because the amount and period over which the Company will beallowed to recover these costs will be mandated by the PUCT.  The PUCT is expected to rule on this matterin June 2005.  See Note 22.**

** **

**11.  MORTGAGE NOTES AND LINE OF CREDIT**

** **

**The CFC notes have beenissued in conjunction with a Second Restated Mortgage and Security Agreement,dated October 24, 1995 (“Loan Agreement”). Substantially all of the Company’s distribution assets arecollateralized in connection with the notes, which have maturity dates rangingfrom 2005 to 2035, with required quarterly payments of principal andinterest.  Under the Loan Agreement, theCompany may elect to pay interest on a fixed or variable interest rate basis,as defined. The existing long-term debt consists of series of loans from CFCthat impose various restrictive covenants, including, among other things,provisions that prohibit the incurrence or guaranty of other securedindebtedness and requires the maintenance of a 1.35 debt service coverageratio, as defined in the CFC Loan Agreements. In addition, the Company may notmake any cash**

 

F-19

----

 

**distribution or anygeneral cancellation or abatement of charges for electric energy or services toits customers if the ratio of equity to total assets is less than 20%.**

** **

**In conjunction with theconversion from a member owned cooperative to a shareholder owned corporation,CFC waived the 20% equity to total assets ratio requirement, consented to thedistribution of cash and electric credits to former members, waived the 1.35debt service coverage ratio requirement as it concerned the conversion andnotified the Company that all existing CFC indebtedness may remain in placewith CFC after the conversion.**

** **

**Substantially all ofthe CFC mortgage notes are subject to interest rate repricing at the end ofvarious periods, at the Company’s option. Mortgage notes with CFC as of December 31, 2004 and 2003, consistedof the following (in thousands):**

** **
| ** **                                                                                                | ** ** | **December 31,** | ** ** |
|-----------------------------------------------------------------------------------------------------------|------------|-----------------------|------------|
| ** **                                                                                                | ** ** | **2004**              | ** ** | **2003** | ** ** |
|                                                                                                      |       |                  |       |   |   |
| Interest at  3.35% at December 2002 and 2003, with interest repricing in January 2004  and 2005 |       | $                     | —     |   | $ | 10,400 |   |
| Interest at  4.20% with interest repricing in January 2005                                           |       | —                |       | 69,109 |   |
| Interest at  4.70% with interest repricing in January 2006                                           |       | 33,017                |       | 34,128 |   |
| Interest at  4.85% with interest repricing in January 2006                                           |       | 6,467                 |       | — |   |
| Interest at  4.50% with interest repricing in January 2007                                           |       | 5,960                 |       | 6,080 |   |
| Interest at  5.15% with interest repricing in January 2007                                           |       | 64,055                |       | — |   |
| Interest at  4.30%                                                                                        |       | 27,872                |       | 28,000 |   |
| Interest at  fixed rates:                                                                                 |       |                  |       |   |   |
| 4.20%                                                                                                     |       | 3,590                 |       | — |   |
| 7.00%                                                                                                     |       | 2                     |       | 2 |   |
| Variable  rate                                                                                            |       | 2,791                 |       | — |   |
|                                                                                                      |       | 143,754               |       | 147,719 |   |
| less current  maturities                                                                                  |       | (9,881                | )          | (4,531 | ) |
| Total  Mortgage debt, net of current portion                                                              |       | $                     | 133,873    |   | $ | 143,188 |   |

** **

**The Company hascapitalized, as a part of utility plant, the cost of borrowed funds used forfinancing construction. Capitalized interest for the years ended December 31,2004, 2003 and 2002, was $21,000, $7,000 and $12,000, respectively.  The rateused for interest charged to construction is the Company’s effective borrowingrate.**

** **

**Annual maturities ofthe mortgage notes as of December 31, 2004, are as follows (in thousands):**

** **
| 2005                |   | $      | 9,881   |   |
|---------------------|--------|--------|---------|--------|
| 2006                |   | 3,653  |    |
| 2007                |   | 30,032 |    |
| 2008                |   | 3,378  |    |
| 2009                |   | 3,525  |    |
| Thereafter          |   | 93,285 |    |
|                |   |   |    |
| Total mortgage debt |   | $      | 143,754 |   |
|                     |        |        |         |        |  |

 

F-20

----

 

**12.TRANSMISSION SYSTEM FINANCING**

** **

**In connection with theoriginal financing and construction of its transmission line, the Companyentered into agreements qualified as capital lease obligations.  As a result, the transmission line,substation assets and associated capital lease obligations were recorded on theCompany’s consolidated financial statements.**

** **

**The original cost ofthe transmission facility and costs related to consummation of the leaseagreements totaled $61,999,000, and were being recovered from customers throughpower cost billings over a ten year period. Consistent with this ratemaking treatment, the transmission facilitiesand capital lease obligation were being amortized over the same ten yearperiod, with that period ending September 30, 2003. The monthly leasepayments included an amount for a sinking fund, which was to be used to reducethe amount of the final balloon payment on the capital lease, which was due September 2003.**

** **

**Regularly scheduledmonthly principal payments on the transmission system capital lease obligationfor the nine months ended September 30, 2003, and the year ended December 31,2002, were approximately $3,556,000 and $5,047,000, respectively.  The corresponding amortization of propertyand equipment under the capital lease was credited to accumulated depreciationand amortization accounts for the transmission facilities consistent withratemaking treatment.**                   Interest on the capital lease obligations for the ninemonths ended September 30, 2003, and the year ended December 31, 2002, was approximately $847,000and $1,443,000, respectively, and is classified as purchased power costconsistent with ratemaking treatment.

** **

FERCapproval was received in August 2003 for NewCorp to borrow $31,500,000from Beal Bank S.S.B. (“Beal Bank”).  Theinitial advance of $14,169,000 was used for payment of the balloon payment onthe transmission system capital lease in September 2003.  Simultaneously, the sinking fund of$8,207,000 was released by the lessee, and used to partially fund a restrictedsecurities account of $14,169,000, which was the only asset collateralized byBeal Bank.

 

Intereston the Beal Bank loan was 10.75%, payable monthly.  The financing arrangement provided for acommitment fee, which totaled $457,000 for the initial advance.  Additional amounts paid to Beal Bank werereimbursement of expenses, attorney fees, appraisals and consulting, which at December 31,2004, aggregated $1,184,000.  Prepaymentof the initial advance was not allowed unless an additional advance was fundedbefore the September 9, 2004, due date. In the accompanying consolidated balance sheet at December 31,2003, the initial advance of $14,169,000 is shown in current liabilitiesbecause it was not certain that the Company would draw on the additionaladvance from Beal Bank.  Two amendmentsto the financing agreement were executed which extended the due date of theinitial advance.  The collateralized cashinvestment was then used to repay the initial advance in November 2004.

 

**13.  NOTE PAYABLE AND OTHER CAPITAL LEASES**

** **

**Previously, the Companyhad a note payable to a bank that was cross-collateralized by a note receivablefrom United Fuel and Energy Corporation (“United Fuel”).  In October 2003, United Fuel consummatedfinancing with a lender that provided for funds to partially pay down theCompany’s note payable to a bank, with United Fuel taking the position asborrower on the Company’s note payable to a bank, thus extinguishing UnitedFuel’s note receivable to the Company. The Company was no longer a borrower and its involvement had beenreduced to being a secondary guarantor for United Fuel’s note of$3,500,000.  Generally acceptedaccounting principles required the Company to record a guarantee obligationthat was measured at fair value.  Aguarantee obligation of $35,000 was recorded, based on factors such as assetcollateralization value and guarantor hierarchy.  United Fuel repaid the note in November 2004,effectively releasing the Company’s guaranty and the recorded guaranteeobligation was then eliminated.**

 

F-21

----

 

**The Company has othermiscellaneous capital leases for certain equipment used in operations, withsuch equipment included in utility plant on the balance sheet.  Future minimum lease payments are as follows(in thousands):**

 
| 2005                            |   | $  | 110    |   |
|---------------------------------|--------|----|--------|--------|
| 2006                            |   | 57 |   |
| 2007                            |   | 18 |   |
| Total capital lease obligations |   | $  | 185    |   |

 

**14.ACCRUED AND OTHER CURRENT LIABILITIES**

** **

**Accrued and othercurrent liabilities at December 31, 2004 and 2003, consisted of thefollowing (in thousands):**

** **
| ** **                                       | ** ** | **December 31,** | ** ** |
|--------------------------------------------------|------------|-----------------------|------------|
| ** **                                       | ** ** | **2004**              | ** ** | **2003** | ** ** |
|                                             |       |                  |       |   |   |
| Accrued  taxes                                   |       | $                     | 18         |   | $ | 18 |   |
| Accrued  interest                                |       | 516                   |       | 520 |   |
| Accrued  payroll and employee benefits (Note 15) |       | 914                   |       | 1,670 |   |
| Regulatory  liability                            |       | 723                   |       | 704 |   |
| Customer  deposits and prepayments               |       | 778                   |       | 760 |   |
| Accrued  other                                   |       | 253                   |       | 230 |   |
| Total Accrued and Other Current Liabilities      |       | $                     | 3,202      |   | $ | 3,902 |   |

** **

**15.  EMPLOYEE BENEFIT PLANS**

** **

**ExecutiveDeferred Compensation Plans**

** **

**In November 2002,the Board approved an Executive Deferred Compensation Retirement Plan wherebymanagement, members of the Board of Directors and certain highly compensatedemployees could defer a portion of their compensation pursuant to the terms ofthe plan.  The Company may also makecontributions to the plan on behalf of the individuals participating in the plan.  A participant is 100% vested in contributionshe may make to the plan, with Company contributions vesting at 10% per year forthe first four years, and 20% per year for the next three years.  The Compensation Committee of the Board ofDirectors administers the plan.  For theyears ended December 31, 2004 and 2003, $18,000 and $16,000 werecontributed to the plan, and such amounts are shown as a liability on theconsolidated balance sheets.**

** **

**StockIncentive Plan**

** **

**The Company has a StockIncentive Plan, approved by the shareholders, that provides for the granting ofawards of common stock, options to purchase common stock, both restricted andunrestricted, and certain related rights to eligible officers, employees anddirectors of the Company.  The plan willcontinue in effect until December 31, 2013.  The Stock Incentive Plan provides for amaximum of 800,000 shares of the Company’s common stock to be used for stockawards and the granting of options.  Sharesof common stock used to satisfy such awards will be acquired by the Plan eitherthrough open market purchases or through the issuance of additional commonstock.  For the years ended December 31,2004, 2003 and 2002, the Company recorded**

 

F-22

----

 

**compensation expense of$4,925,000, $2,133,000 and $30,000, respectively, in connection with the fairvalue of these awards of common stock, of which $1,121,000, $113,000 and $0,respectively, were in the form of shares withheld by the Company, in order toremit cash payments for employees’ payroll tax withholding.**

** **

**Employee StockPurchase Plan**

** **

**The Company has anEmployee Stock Purchase Plan (“ESPP”), also approved by the shareholders, thatprovides its employees with the opportunity to purchase shares of its commonstock through payroll deductions.  It isthe Company’s intention to have the ESPP qualify as an employee Stock PurchasePlan under Section 423 of the Internal Revenue Code of 1986, asamended.  The Employee Stock PurchasePlan provides for a maximum of 150,000 shares. As of December 31, 2004, the ESPP had not been implemented.**

** **

**Stock forCompensation Plan**

** **

**The Company has a Stockfor Compensation Plan (“SCP”) that provides a means for eligible employees anddirectors to receive shares of the Company’s common stock or restricted shareunits in lieu of cash compensation.  Thisplan was also approved by the shareholders. The SCP provides for a maximum of 500,000 shares of the Company’s commonstock to be used in conjunction with this plan. For the years ended December 31, 2004, 2003 and 2002, cash bonusesof $6,000, $6,000 and $367,000, respectively, had been earned by individuals,who then were awarded shares of stock in lieu of the cash compensation.**

** **

**DefinedContribution Plan**

** **

**The Company has a401(k) plan for employees who meet certain eligibility requirements.  The plan permits a specified percentage of anemployee’s salary to be voluntarily contributed on a pre-tax basis, with aCompany matching feature.  Participantsmay contribute from two percent of eligible earnings up to the maximum federallimit to various self-directed investment funds.  The plan provides for various levels ofCompany matching contributions depending upon the level of employeecontributions.  Company contributionsaggregated $535,000, $527,000 and $481,000, for the years ended December 31, 2004, 2003 and 2002.**

** **

**OtherPostretirement Benefits**

** **

**The Company providescontinued major medical coverage to retired employees and theirdependents.  The cost to maintain suchbenefits for the years ended December 31, 2004, 2003 and 2002, totaled$235,000, $399,000 and $858,000, respectively.**

** **

**The Medicare Reform Actof 2003 allows employers who sponsor a postretirement health care plan thatprovides a prescription drug benefit to receive a subsidy for the cost ofproviding that drug benefit.  In orderfor employers to receive the subsidy payment under the Medicare Reform Act, thevalue of the offered prescription drug plan must be at least actuarially equivalentto the standard prescription drug coverage provided under Medicare Part D.  The Company’s plan meets the actuariallyequivalent test and qualifies for the subsidy. The reduction in current period service cost due to the subsidy was$34,000 for the year ended December 31, 2004, and the impact on thebenefit obligation is $1,562,000.**

** **

**The Company uses December 31as a measurement date for the plan.**

 

F-23

----

 

**Obligations and Funded Status**

**The following tablesset forth the obligations, fair value of plan assets and funded status at December 31,2004 and 2003:**

** **
| ** **                             | ** ** | **December 31,** | ** ** |
|----------------------------------------|------------|-----------------------|------------|
| ** **                             | ** ** | **2004**              | ** ** | **2003** | ** ** |
|                                   |       |                  |       |   |   |
| **Change  in Benefit Obligations**     |       |                  |       |   |   |
| Benefit  obligation, beginning of year |       | $                     | 3,508      |   | $ | 2,868 |   |
| Service cost                           |       | 245                   |       | 206 |   |
| Interest  cost                         |       | 598                   |       | 504 |   |
| Participant  contributions             |       | —                |       | — |   |
| Actuarial  loss                        |       | 380                   |       | 329 |   |
| Benefit paid                           |       | (653                  | )          | (399 | ) |
| Benefit  obligation, end of year       |       | $                     | 4,078      |   | $ | 3,508 |   |
|                                   |       |                  |       |   |   |
| **Funded  Status**                     |       |                  |       |   |   |
| Funded  status - under funded          |       | $                     | 11,349     |   | $ | 9,119 |   |
| Unrecognized  net loss                 |       | (7,271                | )          | (5,611 | ) |
| Accrued  benefit cost                  |       | $                     | 4,078      |   | $ | 3,508 |   |

** **

**Components of Net Periodic BenefitCost**

**The following setsforth the components of net periodic benefit cost for the years ended December 31,2004,  2003 and 2002 (in thousands):**

** **
| ** **                       | ** ** | **December 31,** | ** ** |
|----------------------------------|------------|-----------------------|------------|
| ** **                       | ** ** | **2004**              | ** ** | **2003** | ** ** | **2002** | ** ** |
|                             |       |                  |       |   |   |   |   |
| Service cost                     |       | $                     | 245        |   | $ | 206 |   | $ | 148 |   |
| Interest  cost                   |       | 598                   |       | 504 |   | 471 |   |
| Amortization  of experience loss |       | 380                   |       | 329 |   | 239 |   |
| Net  periodict benefit cost      |       | $                     | 1,223      |   | $ | 1,039 |   | $ | 858 |   |

** **

**Actuarial Assumptions and Cost Trends**

**The following setsforth the assumptions used to determine benefit obligations:**

** **
| ** **    | ** ** | **DECEMBER 31,** | ** ** |
|---------------|------------|-----------------------|------------|
| ** **    | ** ** | **2004**              | ** ** | **2003** | ** ** | **2002** | ** ** |
| Discount rate |       | 5.75                  | %          | 6.00 | % | 7.00 | % |

 

F-24

----

 
| ** **                                               | ** ** | **2004** | ** ** | **2003** | ** ** |
|----------------------------------------------------------|------------|----------|------------|----------|------------|
|                                                     |       |     |       |     |       |
| Health care  cost trend rate assumed for next year       |       | 10       | %          | 9        | %          |
| Rate to  which the cost trend rate is assumed to decline |       | 1        | %          | 1        | %          |
| Year that  the rate reaches the ultimate trend rate      |       | 2010     |       | 2008     |       |

** **

**The assumed health carecost trends significantly affect the amounts reported for the post retirementhealth care liability.  A one percentagepoint change in assumed health care cost trend rates would have the followingeffects (in thousands):**

** **
| ** **                                                | ** ** | **One Percentage Point** | ** ** |
|-----------------------------------------------------------|------------|--------------------------|------------|
| ** **                                                | ** ** | **Increase**             | ** ** | **Decrease** | ** ** |
| Effect on total of service cost and interest  cost        |       | $                        | 133        |   | $ | (105 | ) |
| Effect on accumulated post retirement  benefit obligation |       | 1,392                    |       | (1,136 | ) |
|                                                           |            |                          |            |  |  |  |  |

** **

**Plan Assets**

**No return on planassets was assumed in the calculation as the Company holds no specified planassets.**

** **

**Future Benefit Payments**

**The following tableprovides estimates of future benefit payments, which reflect expected futureservice, as applicable (in thousands):**

** **
| 2005      |   | $     | 849    |   |
|-----------|--------|-------|--------|--------|
| 2006      |   | 838   |   |
| 2007      |   | 855   |   |
| 2008      |   | 827   |   |
| 2009      |   | 776   |   |
| 2010-2014 |   | 4,019 |   |

** **

**16.DEFERRED CREDITS**

** **

**Deferred credits at December 31,2004 and 2003, consisted of the following (in thousands):**

** **
| ** **                                           | ** ** | **DECEMBER 31,** | ** ** |
|------------------------------------------------------|------------|-----------------------|------------|
| ** **                                           | ** ** | **2004**              | ** ** | **2003** | ** ** |
| Post retirement benefits (Note 15)                   |       | $                     | 4,078      |   | $ | 3,508 |   |
| Deferred gain on sale of United Fuel Stock  (Note 7) |       | 940                   |       | — |   |
| Stockholders’ Trust (Note 21)                   |       | 129                   |       | — |   |
| Deferred executive compensation                      |       | 36                    |       | 44 |   |
| Unclaimed member capital credits                     |       | 55                    |       | 67 |   |
| Other                                                |       | 56                    |       | 58 |   |
| Total Deferred Credits                               |       | $                     | 5,294      |   | $ | 3,677 |   |

 

F-25

----

 

**17.FAIR VALUE OF FINANCIAL INSTRUMENTS**

** **

**The following tablepresents the carrying amounts and estimated fair values of the Company’sfinancial instruments at December 31, 2004 and 2003.  SFAS No. 107 defines the fair value of afinancial instrument as the amount at which the instrument could be exchangedin a current transaction between willing parties (in thousands):**

** **
| ** **                 | ** ** | **DECEMBER 31,** | ** ** |
|----------------------------|------------|-----------------------|------------|
| ** **                 | ** ** | **2004**              | ** ** | **2003** | ** ** |
| ** **                 | ** ** | **BOOK  VALUE**       | ** ** | **FAIR  VALUE** | ** ** | **BOOK  VALUE** | ** ** | **FAIR  VALUE** | ** ** |
| ** **                 | ** ** | ** **            | ** ** | ** ** | ** ** |
| Cash                       |       | $                     | 20,968     |   | $ | 20,968 |   | $ | 12,170 |   | $ | 12,170 |   |
| Restricted cash investment |       | —                |       | — |   | 14,169 |   | 14,169 |   |
| Notes receivable           |       | 1,300                 |       | 1,300 |   | 1,250 |   | 1,250 |   |
| Mortgage notes             |       | 143,754               |       | 143,754 |   | 147,719 |   | 147,719 |   |
| Short-term note payable    |       | —                |       | — |   | 14,169 |   | 14,169 |   |
|                            |            |                       |            |  |  |  |  |  |  |  |  |  |  |

** **

**The book value of cashand cash equivalents approximated fair value because of the short maturity ofthose instruments. The carrying values of accounts receivable and accountpayable included in the accompanying consolidated balance sheets approximatedmarket value at December 31, 2004 and 2003. As described in Note 11, theCompany has both fixed rate and variable rate notes.  The fair value of these mortgage notes is notable to be readily determined because there is no market for this type of debt.**

** **

**18.MAJOR CUSTOMERS AND SUPPLIERS**

** **

**For the years ended December 31,2004, 2003 and 2002, the Company and its subsidiaries had no customer thataccounted for more than 10% of operating revenues.**

** **

**The Company utilizes anindependent third party for its materials warehousing function.  The terms of the contract provide that thethird party maintain an adequate inventory level of distribution typecomponents, with after hours staffing in case of emergencies.  The Company has also outsourced its meterreading function.  In the event thecontract with the third parties should not be renewed, the Company believes itsoperations would not be severely affected because new contracts could besecured at competitive rates and in a timely manner.  See also Note 22, Commitments andContingencies.**

** **

**19.ELECTRIC DEREGULATION AND CUSTOMER CHOICE**

** **

**On May 27, 1999, theTexas legislature passed a bill relating to the restructuring of the electricutility industry in Texas. The bill, among other things, provided for retailcompetition to begin on January 1, 2002. Municipally owned utilities andcooperatives could elect, but were not required, to offer retail customerchoice on or after January 1, 2002. The Company met the definition of a “cooperative” under thislegislation. **On June 22, 2003, the Governor of theState of Texas signed Senate Bill 1280 into law which became effective September 1,2003.  The definition of “electriccooperative” under the Public Utility Regulatory Act (“PURA”) included a “successorto an electric cooperative created before June 1, 1999, in accordance witha conversion plan approved by a vote of the electric cooperative, regardless ofwhether the successor later purchases, acquires, merges with or consolidateswith, other electric cooperatives.”  SB1280 amended the PURA to treat a successor to an electric cooperative as aninvestor owned utility.  This legislationalso provided for establishment of schedules and procedures by the PublicUtility Commission of Texas for such a successor that was not previouslysubject to

 

F-26

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**regulation as an investor owned utility prior to September 1,2003, in order to comply with the requirements of deregulation andcompetition.  The Company’s rates are nowsubject to regulation and approval by the PUCT, not the Company’s Board ofDirectors.**

** **

**Under the new law, thePUCT will establish schedules and procedures for the Company to comply with therequirements of competition.  Because theSouthwest Power Pool (“SPP”) does not have adequate infrastructure for customerchoice, House Bill 1642 provides that the utilities in the SPP cannotparticipate in customer choice until 2007. Since the SPP still does not have adequate infrastructure for customerchoice, it is expected that such date will be extended by the legislature.  The majority of the Company’s service area isin the SPP, while approximately 25% is in ERCOT.  While the PUCT could order the Company tobring its ERCOT territory into customer choice sooner than the law provides forcustomer choice to be provided by utilities in the SPP, such action would onlyserve to harm the Company’s customers and the Company does not believe the PUCwill take such action.  The Companybelieves the PUCT will be reasonable in developing appropriate schedules andprocedures for the Company to enter into customer choice and that such actionwill not adversely affect the Company’s customers.**

** **

**20.RELATED PARTY ACTIVITY**

** **

**One of the compensationvehicles utilized by the Company was the Achievement Based Contract –Southwestern Public Service Company (“ABC-SPS”).  The ABC-SPS contract provided for totalcompensation of 2% of the annual savings derived from the SPS purchased powercontract, as compared to the prior Texas Utilities purchased powercontract.  Two executive officers werethe only remaining participants in the ABC-SPS contract, which expired in October 2003.  For the years ended December 31, 2003and 2002, compensation attributable to the contract was $126,000 and $156,000,respectively.**

** **

**Two other compensationarrangements, the Achievement Based Compensation Contract – Merger orAcquisition with Other Electric Utilities, and the Achievement BasedCompensation Agreement – Corporate Asset Non-CFC Financing Arrangements, werealso in place in prior years.  Thesecompensation arrangements were cancelled in March 2005, and no amounts hadbeen paid or accrued for the years ended December 31, 2004, 2003 and 2002.**

** **

**21.  OTHER SHAREHOLDER MATTERS**

** **

**The Cap Rock EnergyCorporation Shareholders’ Trust (the “Trust”) was established by the Company inOctober 2002, on behalf of former members of the Cooperative whose currentaddresses are unknown and would have received shares of common stock inconnection with the conversion of the Cooperative into the Company.  The shared authority of the two Trustees ofthe Trust is to make distribution of stock to beneficial owners when they havebeen located.  As of December 31,2004 and 2003, there were 325,223 and 340,738 shares of stock, respectively, held beneficially by the Trust.**          Other powers are limited to those granted inthe Trust document, the Funding Agreement and the Share Option Agreement.

** **

**The Trust provides thatin the case of a tender offer or other repurchase offer by the Company forshares of the capital stock of the Company, the Trustees may, in their solediscretion and acting jointly in the best interest of the beneficiaries of theTrust, sell all of the shares held in the Trust to the Company at the highestcash price offered under the tender offer or other repurchase offer.  If the tender offer by the Company has a premiumof 25% or more, the Trustees shall sell all of the shares at the highest cashprice offered.  In addition, the Trusteesshall not vote the shares in favor of a sale or pledge of assets of theCompany, nor for any change in the capital structure or powers of the Companyor in connection with a merger or dissolution, unless previously approved bythe Company’s Board of Directors.**

 

F-27

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**On December 31,2004, the Trust and the Company entered into a Voting Agreement whereby theshares that are currently held in the Trust will be voted by the Trustees butas directed by the Company for so long as the shares are held in the Trust, orby the State in the event the shares escheat. As consideration, the Company will pay a 10% premium of the value of theshares as of December 30, 2004, to any owner of shares currently held inthe Trust, at such time as the shares are issued to the legal owner or his orher heirs.**  At December 31,2004, a liability based on fair value of $129,000 was recorded, and is shown asa long term liability in Deferred credits on the consolidated balancesheet.  See Note 15.

** **

**22.COMMITMENTS AND CONTINGENCIES**

** **

**The Company has variousobligations to make future payments under contractual obligations:**
| ** **                   | ** ** | **2005**                   | ** ** | **2006** | ** ** | **2007** | ** ** | **2008** | ** ** | **2009** | ** ** | **Thereafter** | ** ** | **Total** | ** ** |
|------------------------------|------------|----------------------------|------------|----------|------------|----------|------------|----------|------------|----------|------------|----------------|------------|-----------|------------|
| ** **                   | ** ** | **(Thousands of dollars)** | ** ** |
| Operating  lease obligations |       | 485                        |       | 396      |       | 322      |       | 137      |       | 137      |       | 91             |       | 1,568     |       |
| Purchase  obligations        |       | 6,969                      |       | 2,099    |       | 2,099    |       | 402      |       | 402      |       | 2,802          |       | 14,773    |       |
| Other long  term liabilities |       | 1,543                      |       | 1,531    |       | 921      |       | 859      |       | 797      |       | 33,926         |       | 39,577    |       |

** **

**Operating leases relateprimarily to equipment.  Purchaseobligations include IT services and power contracts.  All of the Company’s power contracts arefirm, full requirements contracts.  Thesetypes of contracts require the Company to purchase all of its power needs fromthe seller, but do not mandate a minimum purchase amount.  The amounts included for each year are basicrequired transmission charges.**

** **

**The Company has enteredinto an agreement with a third party to provide certain information technologyrelated managed services including assessment of the current IT environment andfuture needs; product selection; implementation of financial and operational ITsystems; hosting of the applications in a remote environment; user andapplication support, as well as desktop support.  Beginning March 2004, ongoingmaintenance and support costs is be based on the number of meters perrespective month and, based on the number of meters at December 31, 2004,will approximate $1,697,000 per year through 2007.  These amounts are reflected in the abovetable under Purchase obligations.  If atermination of services occurs before the end of the contract, except formaterial nonperformance, the Company will be required to pay a termination feeon a decreasing sliding scale over the term of the contract.  The maximum amount for such termination feeis $1,414,000.**

** **

**The Company has acontract with the City of Farmersville, Texas, to act as an agent to providepower to its customers and assume all related billing and collectionfunctions.  Terms provide for a two yearwritten notification for termination by either party.  The Company is obligated to make payments tothe City of Farmersville on a revenue sharing type basis.  The 2005 and estimated 2006 annual paymentsare $621,000 and are reflected in the table under Other long term liabilities.**

** **

***Purchased Power andTransmission Services. ***The Company purchases all of its electric powerpursuant to long-term wholesale electric power contracts with SouthwesternPublic Service Company, Lower Colorado River Authority (“LCRA”) and GarlandPower and Light (“Garland”). SPS, LCRA and Garland contracts expire in 2013,2016 and 2005, respectively, and account for approximately 74%, 14% and 12%,respectively, of the Company’s electric power purchases for 2004. The contractsfor power cover kWh usage, kW demand levels, transmission, scheduling andancillary services along with energy and fuel costs. The Company’s purchasedpower costs fluctuate primarily with the price of the fuel and usage.Management believes that in the event the contracts are terminated, the Company’soperations will not be severely affected as new contracts can be secured atcompetitive rates with other electric power providers.  However, all costs associated with purchasedpower are passed through to the retail customer.

 

F-28

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**The Company’s westTexas divisions are supplied power through a contract with SPS. The SPScontract has no minimum kWh usage requirements, but does have minimum chargesfor kW demand and transmission services. The Company must pay a minimum of 65%of the prior twelve months highest monthly kW demand usage multiplied by afixed rate along with their pro-rata share of the fixed transmission costsbased on the Company’s prior twelve months usage as a percentage of all SPSusage. The SPS contract allows the Company to purchase all power needed.Energy, kW demand, ancillary services and scheduling charges are based on fixedfactors charged against usage. The Company also pays a pro-rata share of SPS’sFERC regulated transmission charges. Fuel costs paid to SPS are based on SPS’sactual cost of fuel used to generate electricity.  The aggregate cost of the contract with SPSfor 2004 and 2003 was $27,322,000 and $23,114,000, respectively.  The SPS contract expires in December 2013.**

** **

**The LCRA contractcovers all power utilized by the central Texas division of the Company andpermits the Company to purchase 100% of the power needed to supply the nativeload of the division. LCRA charges the Company fixed factors for energy, kWdemand and scheduling services applied to our usage. LCRA’s transmissioncharges are fixed monthly charges regulated by the Electric Reliability Councilof Texas (“ERCOT”). Fuel costs paid to LCRA are the Company’s pro-rata share ofthe amounts that LCRA actually pays for fuel to generate electricity. TheCompany is required to purchase power from LCRA, but has no minimum usage levelsand only minimal penalties. The contract between LCRA and the Company expiresin June 2016.**

** **

**Garland provides allpower supply requirements, including ancillary and scheduling services, for thedivision in northeast Texas and the City of Farmersville.  The Company is not required to purchase aminimum amount of capacity, and is billed solely on actual usage.  The price per kWh is at a fixed rate and doesnot fluctuate with the price of gas or other fuels.**

** **

**Various members ofERCOT provide the northeast Texas division of the Company with transmissionservices. The PUCT regulates the transmission rates that are charged by theERCOT members. The Company pays a fixed monthly fee based on the estimatedusage submitted prior to the beginning of each year. There is no contract withthe individual ERCOT members. Taking power over the ERCOT network requires theCompany to pay fees regulated by the PUCT. The annual charges to use the ERCOTtransmission network cover the period from January 1 to December 31of each year. Withdrawing from ERCOT and using other transmission servicesrelieves the user of further charges. Because the use of the network isgoverned by ERCOT and falls under the jurisdiction of the Texas Public UtilityCommission, a contract is not required with each ERCOT member.**

** **

***Outsourced Functions. ***The Company utilizes an outside third party forits materials warehousing function.  Theterms of the contract provide that the third party maintain an adequate levelof inventory in order that the Company may meet its needs in a timelymanner.  The exclusive contract was foran initial term of 5 years, and has been extended and modified for another 5years through November 2006.  Theterms of the contract also provide for termination at any time by either partywith 90 days written notice.  Upon anyfinal contract termination by either party, the Company is required to purchaseand pay for any inventory held by the third party at cost plus 10%.  The estimated inventory value plus 10% isapproximately $1,091,000 at December 31, 2004.

** **

**The Company has alsooutsourced its meter reading function. The basic terms of the contract provide for a fee per meter read, withthe contract extended through 2008, unless either party gives 150 days writtennotice at any time.**

** **

***PUCT Oversight andDecisions.*****Because of a change in the PublicUtility Regulatory Act (“PURA”), as of September 1, 2003, the Company’s rates became subject toregulation and approval by the PUCT, not the Company’s Board of Directors.  In accordance with this change in the PURA,the Company filed its tariffs for electric service on September 2,2003.  The staff of the PUCT reviewedthose tariffs and provided comments and proposed changes to bring the tariffsinto compliance with PUCT rules and regulations.  Because the tariffs, when adopted, were notsubject to PUCT regulation, some of the provisions did not comply with PUCTrules and

 

F-29

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**regulations since that was not a requirement whenthe tariffs were adopted.  Now that theCompany is subject to PUCT regulation, the Company made proposed amendments toits tariff as suggested by the PUCT staff. The PUCT staff reviewed the proposed changes and recommended that thetariff be approved.  Prior to theAdministrative Law Judge entering a ruling approving the tariff, with theproposed changes, several of the group of intervenors in the case weresuccessful in obtaining a legislative request that the matter be referred tothe State Office of Administrative Hearings (“SOAH”) for a hearing on themerits.  As a result, the matter wasreferred to SOAH and a hearing is currently scheduled for April, 2005.  The hearing will be limited to whether thetariffs filed by the Company are the actual tariffs that were properly approvedby the Company’s Board of Directors, which was the Company’s previousregulatory authority.  The Companybelieves the issue is moot because any current tariff will be superseded by thetariff that is ultimately approved by the PUCT in the rate case.**

** **

InOctober 2004, the PUCT initiated an inquiry to determine thereasonableness of the Company’s rates and ordered the Company to submit a ratefiling package.  The Company prepared andfiled a rate filing package that contained a request for a rate increase forsome customer classes.      The Company initially requested a $6,333,000overall annual after tax increase but due to adjustments made while preparingfor the hearing on the merits in the case, that amount was adjusted downward to$5,021,000.  Hearings were held beforethe State Office of Administrative Hearings from October 5, 2004, through October 14,2004.  During such hearings, the Companypresented testimony and evidence in support of its requested rateincrease.  Numerous intervening partiesand the PUCT staff presented evidence and testimony in opposition to the rateincrease and in support of a rate decrease. The parties filed briefs in support of their positions and the Companyhas agreed to extend the effective date for the requested rate increase until June 17,2005.  A hearing was held in December 2004,to determine the amount of rate case costs that the PUCT will allow the Companyto recover from its customers, as well as the period of recovery.  The Company believes all of its rate casecosts are reasonable and necessary and should be recoverable.  Any amount not allowed for recovery will beexpensed immediately.  As of December 31,2004, $3,593,000 of third party costs had been incurred in connection with therate case, and are shown on the balance sheet as a regulatory asset becausethey were deferred pending approval of recovery by the PUCT.

 

**On March 17, 2005, the Administrative LawJudges (“ALJ’s”) issued a Proposal for Decision (“PFD”).  The PFD recommended a 7.49% rate decrease forCap Rock.  This amounts to an annualrevenue decrease of approximately five million dollars.  Several intervenors had sought rate decreaseswhich were much larger than the recommendation of the ALJ’s.  The recommendation by the ALJ’s will beconsidered by the PUCT at an open hearing. A final ruling, which can be appealed by Cap Rock or any of theintervenors, is expected by June 2005.**

** **

**The Company feels that its rates and its requestedsmall rate increase are justified and that its evidence support that.  The Company will request that the PUCT rejectthe recommendation of the Administrative Law Judges and grant its requestedrate increase.  The Company has receivedrecommendations from Administrative Law Judges in the past which were not inits favor, only to prevail when the issues were considered by the PUCT.  The Company believes its rates are reasonableand that the requested rate increase is appropriate based upon its cost ofservice and reasonable return on its rate base. However, the Company cannot determine what action the PUCT will takewith respect to the PFD.**

** **

Ifthe Company’s request for a rate increase is approved by the PUCT, the Companymay suffer a decline in its customer base. Because the outcome of the rate request or rate order is unknown untilthe PUCT makes a final ruling, the Company is unable to predict the effect ofsuch ruling.

 

**The Company determined during the rate case thatpower costs had been overcollected under the Company’s retail tariffs throughthe power cost recovery process.  Thiswas disclosed to the PUCT at that time. These monies are currently being returned to customers through powercost recovery refunds.  Thisovercollection is partially**

 

F-30

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**offset by a credit applied to power cost recoverydue to the change in accounting principle to record revenues by the accrualmethod, rather than the as-billed method. Legal issues regarding this over recovery and the method of refunding itare being discussed with the PUCT staff and the ultimate outcome is currentlyunknown.  The Company has recorded aliability for these costs.  However, thisis subject to PUCT approval.**

** **

**The Company received two Notices of Violation (“NOV”)from the PUCT in September 2004. These NOV’s, which contain recommendations of the PUCT staff, are theresult of changes in the Public Utility Regulatory Act (“PURA”) passed in 2003,which changed the way the Company was regulated.  Prior to September 1, 2003, the Company’srates were lawfully regulated by its Board of Directors, the same way allelectric cooperatives in the state are regulated.  During the 2003 legislative session, a smallgroup of customers, who were opposed to the Company’s conversion from anelectric cooperative to a shareholder owned corporation, were successful ingetting the law changed so that the Company would be regulated by the PUCTinstead of its Board of Directors.  Thechanges, which took effect September 1, 2003, applied only to the Companyand did not affect the way any other utility in the state is regulated.**

** **

**The NOV’s cite the Company for charging late fees toresidential customers who did not pay their bills on time, and for charging aregulatory surcharge to customers to recover costs incurred in a prior PUCTproceeding.  Both of these charges weremade in accordance with the Company’s tariff which had been adopted by itsBoard of Directors in accordance with Texas law at the time.  Once the Company came under the regulatoryauthority of the PUCT on September 1, 2003, it filed those tariffs withthe PUCT and the PUCT staff reviewed the tariffs and made recommendations tobring the tariffs into compliance with the rules and regulations of the PUCTand the PURA.  The Company amended itstariffs to make all of their suggested changes and the proposed tariff, withthe amendments, was filed and is currently awaiting approval by the PUCT.  The charges for which the Company was citedrelate to charges that were made under the Company’s legally adopted andapproved tariff.  The Company has filed aproposed tariff which complies with the PUCT rules and regulations, but due toactions of a small group of customers, this tariff has not yet been approved bythe PUCT.**

** **

**The NOV’s also recommend that the Company pay fines andcustomer refunds in excess of $1.3 million. These are the same claims that a small group of intervenors have beenmaking in the Company’s PUCT tariff proceedings.  Once the PUCT ruled that these allegationsshould not be considered with the Company’s tariff filing, they were made inthese enforcement actions.  The Companyfiled answers requesting a settlement conference with the PUCT staff andbelieved that the matters would be disposed of through that conference.  However, a resolution was not reached and inearly November the Company requested a hearing with the State Office ofAdministrative Hearings. **The Company feels strongly about its legalposition on these issues and believes it will ultimately prevail.

** **

ThePUCT has not yet established the procedures and time lines for the Company tocomply with the other provisions of the PURA regarding investor ownedutilities, including offering customer choice for customer powerrequirements.  The Company anticipatesthat the PUCT will take relevant factors into consideration in establishingsuch procedures and time lines that are appropriate and such actions will notadversely effect the Company’s customers.

 

***Lamar. ***Discovery is ongoing in the litigationinvolving the Company and Lamar Electric Cooperative Association, Inc. (“Lamar”)which arose out of Lamar’s termination of the Combination Agreement betweenLamar and the Company in October 2002 and the Management ServicesAgreement in November 2002.  Lamarfiled suit against the Company in the 62nd District Court in LamarCounty, Texas, seeking a declaratory judgment that it had a right to terminateboth agreements without regard to payment of any kind to the Company.  The Company believes that Lamar’s statedreason for termination of the Combination Agreement does not fall within thespecific allowable exceptions set forth in the agreement, and therefore theCompany is seeking reimbursement of all costs and expenses incurred with regardto the attempted combination which amount to at least $1.4 million as

 

F-31

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**well as a cancellation fee of $300,000 forliquidated damages as set out in the terms of the Management ServicesAgreement.**

** **

**In October 2004, the Company filedcounterclaims against Lamar’s Board of Directors and two individualdirectors.  The Company also joinedseveral third parties alleging fraud, civil conspiracy and tortuousinterference with business relations. Lamar has also amended its suit against the Company, adding claims forfraud and misrepresentation.  It is likelythere will be additional discovery on the new claims, and the matter will mostlikely not go to trial prior to the fourth quarter of 2005.**

** **

***Other. ***The Company is involved in various litigationmatters, none of which is expected to have a material impact on the financialcondition, operating results or liquidity of the Company.

** **

**23.  INCOME TAXES**

** **

**The Company accountsfor income taxes in accordance with SFAS No. 109 “Accounting for Income Taxes,”which requires the recognition of a liability or an asset, net of a valuationallowance, for the deferred tax consequence of all temporary differencesbetween the tax basis and the reported amounts of assets and liabilities, andfor the future benefit of operating loss carryforwards.**

** **

**The following is areconciliation of income tax expense as shown in the consolidated statement ofoperations for the years ended December 31, 2004 and 2003 (in thousands):**

** **
| ** **                                                  | ** ** | **December 31,** | ** ** |
|-------------------------------------------------------------|------------|-----------------------|------------|
| ** **                                                  | ** ** | **2004**              | ** ** | **2003** | ** ** |
| ** **                                                  | ** ** | ** **            | ** ** | ** ** | ** ** |
| Income tax  expense calculated at the statutory rate of 34% |       | $                     | 1,124      |   | $ | 4,521 |   |
| Income from  nontaxable entities                            |       | (2,175                | )          | (978 | ) |
| State tax  expense                                          |       | —                |       | 219 |   |
| Expired  capital loss                                       |       | 2,540                 |       | — |   |
| Change in  valuation allowance                              |       | (4,789                | )          | (1,643 | ) |
| Other                                                       |       | 1,160                 |       | $ | (21 | ) |
| Tax expense  (benefit)                                      |       | $                     | (2,140     | ) | $ | 2,098 |   |

** **

**The following is ananalysis of consolidated income tax expense for the years ended December 31,2004 and 2003 (in thousands):**

** **
| ** **  | ** ** | **2004** | ** ** | **2003** | ** ** |
|-------------|------------|----------|------------|----------|------------|
| Current     |       | $        | (2,140     | )        | $          | 2,098 |   |
| Deferred    |       | —   |       | —   |       |
| Tax expense |       | $        | (2,140     | )        | $          | 2,098 |   |

 

F-32

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**The tax effects ofsignificant temporary differences and carryforwards at December 31, 2004and 2003, are as follows (in thousands):**

** **
| ** **                              | ** ** | **2004** | ** ** | **2003** | ** ** |
|-----------------------------------------|------------|----------|------------|----------|------------|
|                                    |       |     |       |     |       |
| Net deferred  tax assets (liabilities): |       |     |       |     |       |
|                                    |       |     |       |     |       |
| Accrued  expenses                       |       | $        | 1,260      |     | $          | 1,007 |   |
| Allowance  for doubtful accounts        |       | 38       |       | 28       |       |
| Net  operating loss carryforwards       |       | 8,714    |       | 7,057    |       |
| Stock  compensation                     |       | 1,320    |       | 751      |       |
| Capital loss  carryforwards             |       | —   |       | 2,765    |       |
| Total  deferred tax assets              |       | 11,332   |       | 11,608   |       |
|                                    |       |     |       |     |       |
| Property and  equipment                 |       | (6,799   | )          | (3,362   | )          |
| Other                                   |       | (1,248   | )          | (172     | )          |
| Total  deferred tax liabilities         |       | (8,047   | )          | (3,534   | )          |
|                                    |       |     |       |     |       |
| Valuation  allowance                    |       | (3,285   | )          | (8,074   | )          |
| Net deferred  tax asset (liability)     |       | $        | —     |     | $          | — |   |

** **

**As of December 31,2004, the Company has net operating loss carryforwards of approximately $25.6million.  The net operating losscarryforwards are scheduled to expire in 2009 through 2024.  The Company has a valuation allowance of$3,285,000 against the net deferred tax asset. This valuation allowancedecreased $4,789,000 from 2003 to 2004 in part because of a change in temporarydifferences and the resulting net deferred taxes, and the changes in netoperating losses between the two years.  TheCompany had a capital loss carryforward of approximately $7.5 million whichexpired in 2004.**

** **

**In early 2004, the IRSnotified the Company that it intended to examine the federal income tax returnof its Predecessor for the year 2001. The Company and the IRS are in the final stages of that process, andManagement believes there will be no material impact on the Company’s financialposition or results of operations.**

 

F-33

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**24.SEGMENT INFORMATION**

** **

**The Company has adoptedSFAS No. 131, “Disclosures about Segments of a Business Enterprise and RelatedInformation.” Substantially all of the Company’s operations are conducted inTexas and involve the distribution and sale of electricity.**

** **

**Business segmentinformation as of and for the years ended December 31, 2004, 2003 and2002,  is as follows (in thousands):**

** **
| ** **                    | ** ** | **TOTAL** | ** ** |
|-------------------------------|------------|-----------|------------|
| Operating revenues            |       |      | ** ** |
| December 31, 2004        |       | $         | 82,624     | ** ** |
| December 31, 2003        |       | 82,844    | ** ** |
| December 31, 2002        |       | 74,637    | ** ** |
| Net income                    |       |      | ** ** |
| December 31, 2004        |       | 5,433     | ** ** |
| December 31, 2003        |       | 11,198    | ** ** |
| December 31, 2002        |       | 8,776     | ** ** |
| Identifiable assets           |       |      | ** ** |
| December 31, 2004        |       | 199,687   | ** ** |
| December 31, 2003        |       | 202,989   | ** ** |
| December 31, 2002        |       | 211,294   | ** ** |
| Capital expenditures          |       |      | ** ** |
| December 31, 2004        |       | 4,583     | ** ** |
| December 31, 2003        |       | 5,209     | ** ** |
| December 31, 2002        |       | 1,517     | ** ** |
| Depreciation and amortization |       |      | ** ** |
| December 31, 2004        |       | 7,416     | ** ** |
| December 31, 2003        |       | 6,754     | ** ** |
| December 31, 2002        |       | 5,834     | ** ** |
| Interest expense, net         |       |      | ** ** |
| December 31, 2004        |       | 7,983     | ** ** |
| December 31, 2003        |       | 8,012     | ** ** |
| December 31, 2002        |       | 7,403     | ** ** |
|                               |            |           |            |  |

 

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**25.  QUARTERLY FINANCIAL DATA (UNAUDITED)**

** **

**The following tablesummarizes results for each of the four quarters in the years ended December 31,2004 and 2003 (in thousands, except per share data):**

** **
| ** **                          | ** ** | **QUARTER ENDED**  | ** ** |
|-------------------------------------|------------|--------------------|------------|
| ** **                          | ** ** | **MARCH 31,** | ** ** | **JUNE 30,** | ** ** | **SEPTEMBER 30,** | ** ** | **DECEMBER 31,** | ** ** |
|                                |       |               |       |   |   |   |   |   |   |
| **Period ended December 2004** | ** ** | ** **         | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** |
| Total revenues                      |       | $                  | 20,288     |   | $ | 22,831 |   | $ | 22,351 |   | 17,154 |   |
| Operating income                    |       | 4,241              |       | 5,966 |   | 1,614 |   | (1,602 | ) |
| Net income before income taxes      |       | 2,249              |       | 4,026 |   | 190 |   | (3,172 | ) |
| Income tax expense (benefit)        |       | 187                |       | 997 |   | (658 | ) | (2,666 | ) |
| Basic earnings per share            |       | 1.32               |       | 1.94 |   | .56 |   | (.90 | ) |
| Diluted earnings per share          |       | 1.27               |       | 1.87 |   | .54 |   | (.87 | ) |
|                                     |            |                    |            |  |  |  |  |  |  |  |  |  |

** **
| ** **                          | ** ** | **QUARTER ENDED**  | ** ** |
|-------------------------------------|------------|--------------------|------------|
| ** **                          | ** ** | **MARCH 31,** | ** ** | **JUNE 30,** | ** ** | **SEPTEMBER 30,** | ** ** | **DECEMBER 31,** | ** ** |
| **Period ended December 2003** |       |               |       |   |   |   |   |   |   |
| Total revenues                      |       | $                  | 22,344     |   | $ | 19,243 |   | $ | 23,343 |   | $ | 17,914 |   |
| Operating income                    |       | 5,457              |       | 4,897 |   | 6,936 |   | 3,679 |   |
| Net income before income taxes      |       | 3,760              |       | 3,283 |   | 4,718 |   | 1,574 |   |
| Income tax expense                  |       | 699                |       | 678 |   | 80 |   | 680 |   |
| Basic earnings per share            |       | 2.35               |       | 2.00 |   | 2.96 |   | .57 |   |
| Diluted earnings per share          |       | 2.25               |       | 1.92 |   | 2.86 |   | .55 |   |
|                                     |            |                    |            |  |  |  |  |  |  |  |  |  |  |

 

F-35

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